Question for Doc and others...When picking short put options, what is your criteria for the strike price? It seems like there's a lot of variables here...option price, low or high delta, Implied volatility, and where you think the price will be at OP EX etc... Do you have any rule of thumbs for delta, and Imp Vol, or what do you look for?
"""When picking short put options, what is your criteria for the strike price?"""
First, I will only short stocks I don't mind owning at the strike, minus the premium. Always have the cash to cover assignment(no margin buying).
The rest depends. Look for wide Bollinger Bands upon entry..this is your IV indicator. The wider, the better). If short term trade...like the stock is a month out to EX, I will short ATM or near OTM options to pick up 1-2k in a months time(eg .40 x 25 contracts). For spreads, this is less important(see my trade I am placing below).
If there is stupid panic selling(we are in it!!) , go out, often to the last month and short(IF THE PREMIUM IS CORRECT!!) Very important. Look at present. The 12Dec, 13Jan, 13Mar and 13Jun are priced correctly(close). The 14Jan32Puts should be almost 7.00(6.91), on the ask and they are 5.95. Sad! I looked that up on my option calculator to make sure, but I first noticed the discrepancy by eyeballing the ATM 32s.
You should have 5 dividends in the ATM Puts and above plus some time premium for 14Jan. Well, 1.25 x 5 = 6.25, so the 14Jan should be priced at 6.25 before the premium is added, and it is trading at this ridiculous 5.95 value already. So how do we take advantage?
What I did in the research to help answer your question is I looked back with my calculator and saw which months were the most "fair"(trading closest to the calculator's values).
I found December. I think the MM's have figured the EX to be B4 the OPEX for Dec, hence the higher values in the premiums for the Puts. Then I look and see which strike (bids) are the highest to short relative to each other. That is my short(worked out to the 34s). It is still too cheap(calculator), so I look for a spread(since my long leg should balance what I am losing on the short leg). Once again I scan the strikes(ask) and see which one is the cheapest in % to neighboring strikes...that is my long leg(32s).
Then I reason, if the PPS is likely to reach my BE by OPEX, which is Dec 21st, which is probably very close to EX, and my birthday, and the end of the Mayan calendar, and perhaps the end of the world...so who gives a #$%$ if this works?...;-)
The spread bid/ask is 1.38/1.60(midpoint 1.49). BE @ midpoint is 32.51. Max loss is $51/spread. Max gain is $149/spread. Risk is EX before OPEX and a re-pricing of the short leg at a greater Delta than the Long leg, eating into gains. Risk, obviously is PPS less than 32.51 @ OPEX(that would be sad).
I am placing this trade for myself on Monday, and will continue adding more , on weakness, to my max allotment/trade(2% of total portfolio) by the end of November, when the run should begin. C'mon, have to do something with our darling at these lows. Remember 1-10 spreads at a time, watch for weakness. I #$%$ out on these MLP's with a total loss of around 8-10k, so be wary and do your own DD. Guess what? I am planning to enter trades on EPD, , PAA , CQP and ETP next Q also. 8 to 9 times(winners) out of 10, means you have to stay in the game...simple odds. Take it on the chin and move on to the next trade....