Those fat premiums on MDVN don't look nearly as appetizing today after a -67% drop in the stock at the open.
Medivation gapped down at the open to $13 and stayed there the rest of the day. The bad news was a failed drug trial. The options, both calls and puts had been bid up out of sight ahead of the announcement. I am glad I did not see that setup a couple days earlier or I would be crying myself to sleep tonight. It just goes to show you that real reward does not come without real risk.
I am not adding any new plays tonight after the markets gave up their early gains twice in a row. If we are going to see some profit taking ahead of the Friday payroll report I want to use it as a buying opportunity.
We do not sell out of the money puts for a few cents and then hope the market does not correct and cost us a fortune to exit. I don't like to risk a dollar to make a quarter.
The concept for Option Writer is to find solid momentum plays with enough volatility to inflate the option premiums. We will sell in the money naked puts ahead of the stock price and let the stock rally to our strike.
Selling in the money puts allows us to capture nearly dollar for dollar the movement in the stock price.
Because we are selling in the money that same dollar for dollar move can go against us as well. For this reason we establish tight stops to take us out of the play for a loss of a few cents rather than let the losers grow and "hope" they rally again. In a typical month we could get stopped out of twice as many plays as we close for a profit but those stops will be minimal and the winners worth the trouble.
If you do not have the ability to sell options you can turn the plays into spreads by buying a lower strike put. This will decrease your margin requirements but it will also decrease your profits.
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)