When Not to Sell Puts

Today, I want to share with you a cool tip and insight that can really come in handy - in certain situations - when you think about timing your short, naked, or cash-secured put trades.

(And, yes, this can also work for covered calls.)

And for some context, I'll show you how it played out with a real world trade conducted inside The Leveraged Investing Club.

Now, what I'm about to show you isn't foolproof in that it always plays out this way, but it's amazing to me how often it does - so if you're unfamiliar with the concept, it's definitely worth noting and filing somewhere in the back of your mind.

Never On a Friday

I first heard of this idea from Jeffrey Saut of Raymond James who's been a student of the stock market for something like five decades now.

He has this great mantra - "Never on a Friday."

Meaning that the stock market rarely bottoms on a Friday.

When you see a big selloff on a Friday, as we did following the Brexit vote, the market rarely snaps back the following Monday.

Instead, Saut notes, investors brood about their losses over the weekend and show up on Monday in a selling mood.

If you're going to see a rebound, it's much more likely to happen on what he calls Turning Tuesday.

Turning Tuesdays in the Stock Market

A Turning Tuesday in the stock market can happen in a couple of different ways:

• It can happen with the market roaring higher from the outset of trading on that Turning Tuesday (with pre-market futures already in the green)
• But in a lot of scenarios you might see continued selling pressure on that Tuesday before, at some point in the day, the market reverses and starts to trade higher again.

Now, obviously, just because the market sells off on a Friday, that doesn't mean we're guaranteed to see a bounce back rally the following Tuesday.

But when the market is in the process of bottoming, it's uncanny how often the process plays out this way.

How to Use This Info to Your Advantage

We were actually on the sidelines for new trades for the previous couple of weeks leading up to the Brexit vote inside The Leveraged Investing Club.

I don't bring politics into the Club, but from a market perspective, I felt that the market's reaction to the then recent Orlando nightclub attack would be an increased expectation of both Brexit and a Trump presidency.

Again, I wasn't trying to be political or callous, but I felt the market would have a lot to digest in the following week or so.

In the days that immediately followed, I was proven totally wrong as polls went in the opposite direction on both issues.

(Which is why I so love our customized put writing strategy where we almost always make money no matter what - even when we're wrong about what we expect to happen).

So we stayed on the sidelines with new trades, and that worked out pretty well because the post Brexit selloff presented us with a lot of opportunities.

And the "Never on a Friday" mantra helped us with our timing.

Morgan Stanley Revisited

I love high quality businesses and stocks, but there can also be tremendous put writing opportunities with stocks like MS (Morgan Stanley).

Profitable, super cheap valuation, and almost universally hated.

At the time of this writing, any time the stock traded near enough to the $22 strike price, that's where I would start to write or sell puts on it:

• On April 7, 2016, with the stock trading at $23.76/share, we sold June 17 2016 $22 puts on MS for $0.82/contract.
• One week later, after the stock had shot back higher to $26.07, we bought back the puts for just $0.28.

(The numbers were skewed by the abbreviated holding period, but it still worked out to be a 101.94% annualized return over 7 days.)

Never On a Friday - Great Timing Insight

So fast forward to the Brexit vote and the U.S. stock market selling off the next day (Friday) and the opening the following Monday with continued selling pressure.

I honestly didn't see how Brexit changed things all that much, at least in the near term, and so I felt that the market selloff was a short term overreaction.

In short, I expected one of Saut's Turning Tuesdays.

And I loved where MS was trading again, and implied volatility levels were through the roof (meaning put sellers were getting paid a ton to sell puts).

This time, with the stock trading @ $23.30 on Monday, I again opened a short put position @ $1.24/contract (for the September 16, 2016 expiration date).

How the Trade Worked Out

Sure enough, the stock bounced back on Tuesday to close at $24.61.

In fact, the market was strong all week, so much so that I started getting a little concerned that the move up was unsustainable, and the market was nearing some familiar resistance levels once again.

So just 3 days later, on Thursday, June 30, 2016, with MS now trading at $25.86, I chose to buy back and close my September $22 short put position for $0.43/contract.

(Again, I originally sold or wrote the position for $1.24/contract.)

Obviously, the results were way skewed (again!) by the abbreviated 3 day holding period, but the returns worked out to be 387.18% annualized.

For some perspective, based on the original terms of the trade - a projected 81 day trade until expiration - the position was set to deliver 24.27% annualized returns (on cash-secured capital) over those 81 days.

The Benefits of "Never on a Friday"

By exiting the trade early, I banked smaller total returns, but I did it in a small fraction of the original expected holding period.

Or said another way, I booked roughly 60% of the trade's potential gains in about 5% of the original expected holding period.

(That's kind of like collecting 60% of your salary from an 81 day period in just 3 days and then taking a 78 day weekend.)

And, in the process, I placed myself in position to possibly re-enter the trade if, at some point, the stock pulled back again.

I owe a lot of the success of the trade to Jeffrey Saut's psychologically sound "Never on a Friday" stock market adage.

It kept me from entering the trade too soon (during the massive Friday sell off).

And it also kept me from freaking out too much and paralyzing me on the sidelines.

Like I said - there's definitely an insight here you might want to file away somewhere.

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