EDUCATION (IRA): SPY SHORT PUT VERTICALS VS. SHORT PUTS

Short puts or short put verticals in a cash secured environment? Here's a comparison and contrast of the advantages of going short put vertical over naked put.

Pictured here is a 50-wide* SPY short put vertical in the January monthly with the short option leg camped out at the 17 delta and the long 50 strikes out from there. Here would be the metrics for the short put and the 50-wide:

Stand-Alone 332 Short Put:

Buying Power Effect (Cash Secured): 328.65
Break Even: 328.65
Max Profit: 3.35
Return on Capital at Max: 3.35/328.65 = 1.02%
Return on Capital Annualized: 1.02% x (365/50) = 7.45%
Trade Management Advantages/Disadvantages: Easier to roll for a credit


282/332 Short Put Vertical:

Buying Power Effect (Cash Secured): 47.27
Break Even: 329.27
Max Profit: 2.73
Return on Capital at Max: 2.73/47.27 = 5.78%
Return on Capital Annualized: 5.78% x (365/50) = 42.19%
Trade Management Advantages/Disadvantages: Difficult to roll for a credit on break even test

Seems like a no brainer to go with the short put vertical over the short put every time: The buying power effect is less than 15% of the naked short put while the ROC%-age at max is 81.5% of what you'd get for "going naked." That being said, this doesn't mean that you should deploy 100% of your buying power in short put verticals, since there is one aspect of these that people overlook, and that is assignment risk on the short option leg,** so you either (a) have to keep buying power free in the eventuality that price does break your short option leg and/or break even; (b) cut your losses short at particular loss metrics;*** and/or (c) trade cash-settled products that don't have that risk.

Consequently, when I'm on an acquisitional bender, I tend to take a short of hybrid approach with spreads, deploying them with the notion that I'm fine with acquiring shares at the short option leg price (minus any credit received, of course), but limiting my max loss in the event that the underlying totally breaks down below the long option leg. On assignment, this makes my selling call against task potentially easier because the ground I have to make up is limited to the width of the spread.

For example, SPY goes to 250. In the case of the spread, I exit the long option at or near max (closing for a 32.00 credit -- the difference between the long option strike and current price) and get assigned shares at the short option strike (a 332.00 debit): I can sell call against at current price + the width of the spread or at the 300 strike and still get out of the trade profitably if SPY pops back up to 300.****

With the short put, I'm generally forced to sell call against at or above my cost basis if I want to potentially exit the trade profitably, which would be around 329 here in this example.


* -- I'm using a 50-wide here just for comparison and contrast purposes, put there is actually a "sweet spot" where ROC%-age on the spread is the highest. I generally start out with the 16 delta for the short option leg (it's the 2 x expected move strike) and then fiddle with the long to get 10% or greater ROC%-age for the spread. I'm using SPY here, but the general principles apply to any underlying.
** -- This is naturally only in products like SPY, QQQ, IWM, etc. which are not cash-settled. SPX, RUT, and NDX are cash-settled, so the risk of assignment isn't an element of those trades, which is why I go for those products over the exchange-traded funds when I'm not interested in taking on or risking taking on shares in the underlying.
*** -- I have previously used 2 x the credit received as a good rule of thumb.
**** -- Here's the math: On fill: 2.73 credit + 32.00 credit for closing the long put at or near max - 332.00 debit for the assignment at the 332 strike = 297.27. I will also get a credit for selling a call the shares I was assigned. I can actually sell a call at the 297 strike and still be profitable on a finish above 297 because of this.

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