What To Do If Sell Put Is Exercised

So now we have gone through the entry rules for selling put options as well as the strike price and expiration date selection.

This chapter is dedicated to what to do when our put options gets exercised.

What I realised is that most people are afraid of their put option being exercised.

The reason for that is because they will see red in their portfolio.

Remember that our sell put options are exercised when the share price is below the strike price at the time of expiry.

Here's an example:

So that is what I mean, when a put option get exercised, very likely, you will be looking at a paper loss on your portfolio.

This is normal - however, most people are uncomfortable with this.

After all, not many people are okay with seeing red in their portfolio.

However, this is also the reason why most investors are not able to make money consistently from the stock market.

Whenever they see red in their portfolio, they are thinking of selling it and making a loss - for the fear that the stock will keep falling.

This is also why I always stress on only buying companies that passes the  8-Point Checklist.

Why? Because quality companies will increase its earning in the long run - and that in turns, drives their share price up.

Now, once you can get over the fact that it is okay to let your put option get exercised as long as you followed the entry rules - let's discuss what can we do when our put options are exercised.

The "5%" Milking Strategy

The number 5% actually represents the amount of cash flow we aim to get from the stock in a year.

Now, what do I mean by cash flow?

It really means the real cash that is entering your brokerage account - kinda like dividends.

But in our case, we are looking at option premiums as our source of cash flow. 

So let's say if you have $10,000 position in stock ABC - it means that you are aiming for $500 per year.

Let's go through an example.

Now you get a good sense of what a 5% cash flow means.

That is the amount of cash flow that I would aim for when I have 100 shares because of the put option assignment.

You might be wondering why 5%?

Well, the reason is because when I was a dividend investor in the past - 5% dividend yield was the benchmark that I look for in my dividend stocks.

So this same criteria was used as a reasonable cash flow to "milk" from my positions.

But how do we even get cash flow from our 100 shares that we were assigned due to option exercise?

The answer is selling call options.

What does selling call options means?

Well, when you sell a call option, it means that you promise to sell 100 shares at the specified strike price before an expiry date.

Sounds familiar?

That's because it is the exact opposite from selling put options.

When we sell put options, we are promising to buy 100 shares.

And when we sell call options, we are promising to sell 100 shares.

Here's an example to make sure you understand the concept of selling call options.

When selling a call options, two things can happen:

1. If the share price is below the strike price, the call option will expire worthless.
2. If the share price is above the strike price, the call option will be exercised, and you will have to sell 100 shares.

The main goal is for our call options to expire worthless - since we want to hold the stock until it reaches our exit price.

Now, don't worry if your call options get exercised, there's a plan for that too.

Remember that the exit price can be taken from our profitable watchlist:

Entry Rules of 5% Milking Strategy

The entry rules for the milking strategy is pretty simple:

1. Sell call option when stochastics is high
2. Choose strike price that gives 5% cash flow
3. Choose expiry date of a month or lesser

Sell When Stochastics is High

When the stochastics is high, it is likely that the stock is due for a retracement.

Remember that a call option expires worthless, when the share price is below the strike price at the end of expiry. Therefore, by selling a call option only at high stochastics increases the chances of the call option expiring worthless.

However, it is important to note that the share price can continue to increase further even with a high stochastics. This means that the call option will be exercised.

Even so, there is an action plan when your call option gets exercised.

Choose strike price with 5% cash flow

Remember that for a year, we are aiming to get a 5% cash flow from your investments.

This means that if I sold a put option with a strike price of 20, and the option gets exercised - I will have own 100 shares at $20 each.

That's a $2000 investment.

And 5% of $2000 is $100.

This means that for a year (i.e. 365 days), I should aim to collect $100.

If I am looking at a 30 days option, I will prorate this amount - and aim to collect $8.21. (30/365 X $100 = $8.21)

However, remember to take into account the commissions fees when it comes to selling options.

Typically, it is around $0.65 to $1.50 depending on your brokerage.

So I would aim for around a $10 option premium in this example.

Choose an expiry date with less than a month

Remember that in the entry rules of the sell put strategy, one of the entry rules was to make sure that the stock is highly optionable.

This was for the purpose of the "milking" strategy.

There are some stocks with very little options available, which made it hard to sell call options.

As with selling put options, we want to choose a shorter time period for selling call options to take advantage of a faster time decay.

Simple and straightforward.

However, there are times where your sell call options get exercised, and the stock has yet to reached its exit price.

And this is what we will be covering next.

What To Do If Sell Call Is Exercised

As investors, we want to consider all scenarios.

In this case, there would be a possibility that the sell call is exercised - and your stock has yet to reach its exit price.

Remember that we want to hold our stocks and sell it only at the exit price.

So let's use this as an example.

Let's say I sold a put option at $52 and it was exercised.

Now, I can execute the 5% milking strategy.

So based on the entry rules, I sold a call option that is lesser than a month and gave me the 5% annual cash flow requirement - with a strike price of $57.

However, at the end of expiry - the call option was exercised and I end up selling my shares at $57.

Note that my exit price is at $80. So by selling at $57, I would actually be selling the stocks early.

Therefore, I want to get my stocks back.

I can try to do that by selling a put option at the strike price at $57 again.

If the put option is exercised, then I got back my 100 shares!

If it doesn't get exercised, then I can repeat the process to continue to sell put options at $57.

Here's a image that summarise the process.

Now, you might be thinking - why am I selling a put option at $57 instead of my entry price of $52.

Well, firstly, the share price has already went up to $57 - it is likely that there is not much premium collection at $52.

Also, even if I bought back the stock at $57 - in reality, my cost of investment is actually only $52.

This is because I would have already profited $5 when the $57 call option was exercised.

What's Next

We have now come to the end of the Sell Put Strategy.

As a reminder, it is crucial to follow the entry rules of the Sell Put strategy- especially when it comes to portfolio sizing.

I have seen far too many people get burnt using selling naked put options, which is why I decided to create the Option Investing Hub.

In the next section, we are going to dive deeper into how we can manage our portfolio when using both the long call and sell put strategies.

Note: One of the biggest reasons why the options hub was built as there were too many people who get burnt because of the lack of knowledge of how options works and its risks involved. This resource hub aims to equip beginner investors with the knowledge of options and how they can manage their risks when investing with options.