Using the Free Trade Calculator to Profit on Cash-Secured Puts
Last week, Option Party did something really cool. No, we didn’t take the team skydiving or deep-sea fishing. Instead, we offered readers — subscribers or not — a free trade calculator to download.
Some investors already know how to figure out the probability of success for their prospective options trades. Too many traders just guess though. Instead of figuring out the different probabilities for profit and total loss potential, they just eyeball a few different strikes and go with one.
That’s sort of like the equivalent of a marketing executive dismissing hard data of what’s connecting with customers and just going with the ad campaign they like best. It doesn’t make sense and neither does dart-tossing investment tactics. The more data we have, generally the higher odds we have for success.
Even investors who are more thoughtful in their selection of certain strike prices or expiration dates would be wise to run it through the free trade calculator. At least that way they can apply some calculations to the trade and get some reliable probabilities.
With that said, let’s see what this trade calculator can do. Last week we offered the free trade calculator on the covered call strategy. This week, we’re taking a look at the cash-secured put. The free trade calculator can be found below:
Option Party’s Free Trade Calculator — First Steps
We’re going to use the red-hot Adobe Systems (ADBE) for our example. Some investors have called Adobe a “cloud king” and based on its strong growth, it’s no wonder why. As of July 17th, shares of Adobe are already up 47%. While selling a cash-secured put on a name like Adobe might be best on a larger pullback, we want to use this simply as a hypothetical example.
In order to get the ball rolling here, we need a few inputs. We can’t just say we want a cash-secured put trade on Adobe and have it generate and rank the best trades. (Hint: That’s what a subscription to Option Party will get you!). Instead, we need to give the calculator a few inputs in order to calculate the odds of our trade’s success. In this particular instance, we need to provide: stock price, implied volatility, expiration date, put strike and the put bid.
All of this data can be found on a basic options chain. Once we plug in all of those inputs, the picture above won’t have so many error signs populating it. In our case, we’ll use a stock price of $258.31. We’re going to sell the $250 strike expiring in 31 days on August 17th. That particularly strike has a current bid of $1.11 and an implied volatility of 23.7%.
Unlike most tech companies, this put sale will not capture the company’s earnings release.
Trade Calculator Complete
Once all the data is plugged into the appropriate fields, our free trade calculator can begin feeding us useful information. It should look something like:
Gone are the error signs and we now see helpful probabilities. For instance, our target return in this trade is $111, or the credit we collected. That is our maximum profit as well. In order for that to happen, our trade calculator tells us we need Adobe to close above $250 on expiration day. According to the probabilities, which take into consideration the stock price and standard deviation, there is an almost 68% chance of that happening.
The next row shows the probability of profit. In order for our trade to generate a profit, it needs to close at least one penny above break-even, which is calculated by subtracting the premium from the strike price. This would give us a profit of $1, (multiplied by 100 for each share in the option contract). The calculations suggest there is a 70.1% probability of profit. It would mean that Adobe stock has to close above $248.89 at expiration.
Since we are selling a cash-secured put, we will have to buy 100 shares of Adobe should it close below $250 at expiration. However, between $248.89 and $250 we still have a net credit, which means we still profit even with Adobe between these levels. Below that range and we’re on the hook for some losses.
Finally, the free trade calculator also takes our total risk into consideration. However, this calculation is more helpful in other types of trades (such as spreads). The reason why is simple. In order to realize a max loss, Adobe stock must go to $0 between now and the next month. That’s an unlikely probability to say the least.
The Bottom Line on Using the Trade Calculator
The free trade calculator is an excellent tool for investors. While it can’t scan through and filter vast swaths of data to find the best trades, it can help investors verify a trade they are considering.
Say we are again contemplating a cash-secured put trade in Adobe. To do so, we consider five different strike and expiration combinations. In roughly a minute, we could calculate which of the five has the best probability to become a successful trade. That’s the type of value something like this tool provides, even if it takes a few extra steps to get the data.
Regardless, it’s far better than guessing.