The Ultimate Guide to Managing Short Puts (Turn Losers Into Winners)

If you trade long enough, sooner or later you will have trades that go against you.

You may have just put on a Short Put trade and the market has suddenly tanked and you’re now losing money.

So what do you do if your Short Put is losing money?

And what do you do if your Short Put is In-the-Money (ITM)?

And more importantly, how do you manage your Short Put so that it becomes a winner?

How To Manage Short Puts

Let’s say, for example, you sold an Out-of-the-Money Put that is below the current market price.

And after placing the Short Put, the market starts to go down.

If you were to see your P&L at this point, you would likely see that your trade is in a loss.

So what do you do?

The first step is to take a look at the risk profile of your trade to see where your breakeven point is.

By looking at the risk profile above, we can see that the breakeven point is $376.14.

That means that as long as the market stays above $376.14 at expiration, the trade will be profitable.

So if we were to draw the breakeven point on the chart, it would like like this:

Now that we know where our breakeven point is, we want to map out all the different scenarios that can happen and then plan a course of action for each of the scenarios.

Scenario 1: The market is above the breakeven point.

Since we will be profitable if the market stays above our breakeven point at expiration, then there’s no need to do anything if the market does not go below our breakeven point.

Even if it goes past our Short Put strike, there’s no need to panic.

However, if you are more defensive and don’t want to wait until the point where it breaches the breakeven point, then as long as the market is above the Short Put, there’s no need to do anything.

So whether you choose the breakeven point or the Short Put strike price as the marker for whether you will have to manage your trade or not is entirely your decision to make.

Both ways are fine.

If you’re more defensive, go with the Short Put strike as your marker.

If you want to give more room for your trade to work out, then use the breakeven point as your marker.

So for this scenario, as long as the market is above either the Short Put or the breakeven point, there’s absolutely nothing to do.

Scenario 2: The market goes below the breakeven point.

Now, what if the market has now gone below the breakeven point (or the Short Put if you’re more defensive)?

First of all, we need to identify where is our cutoff point for our max loss.

That’s because a Short Put is an undefined risk strategy.

That means, theoretically, we can lose money all the way till the stock goes to zero.

And since our breakeven point is at $376.14, that means theoretically we could lose $37,614 if the market goes to zero.

While theoretically, that can happen, in reality, it’s highly unlikely.

Nevertheless, we still need to have a max cutoff point in place so that we won’t lose nearly that much if the trade goes wrong.

So how do we identify our max loss for this trade?

By looking at the Buying Power Requirement (BPR) for this trade.

The image above shows the order ticket for this Short Put trade.

The bottom shows the BPR for the trade which is $6,651.85.

This is the capital that you need to put up for this trade.

And this number is derived from the broker’s calculation of what the worst likely risk would be on the trade.

And most of the time, this BPR encompasses the majority of the losses that can happen.

The broker has to protect themselves, so this amount is usually much bigger than most of the losses that could occur from the trade.

Hence, we can use this BPR as the max loss for our trade.

That means to say, if the trade reaches a point where it’s losing $6,651.85, this is where we want to manually close our trade.

And this amount should at most be 5% to 7% of your capital.

This way, we will never lose more than 5% to 7% on any given trade.

So in the event, we do hit the max loss on the trade, at least it’s not a huge loss that we can’t recover from.

So the first plan of action, if the market goes below our breakeven point, is to cut loss when the loss reaches the BPR amount.

Now, what if the market goes below our breakeven point but it’s still not at our max loss cutoff point?

Scenario 3: The market goes below the breakeven point but the max loss has not been reached.

In this scenario, it depends on whether there’s more or less than 21 DTE in the trade.

Why 21 DTE?

There are two reasons for this.

The first reason is that when there are lesser than 21 DTE, the chances of the Short Put getting assigned become higher.

As the Short Put gets closer to expiration, the extrinsic value starts decaying rapidly.

And when there’s little extrinsic value left in the Short Put, that’s when there’s a likelier chance of it getting assigned.

The second reason is that you get better performance when you manage your trade at 21 DTE compared to holding till expiration.

And the risk is greatly minimized as well.

The above images show a study done by the folks at TastyTrade comparing a 30-delta Short Put held to expiration versus managing at 21 DTE.

And the results clearly show that you get better results when you exit your trade at 21 DTE.

You also reduce your maximum loss significantly.

So our next plan of action comes down to whether there are more or less than 21 DTE left.

If there are more than 21 DTE left, then we do nothing.

That’s because there’s still time left for the trade to work out and it’s not in danger of getting assigned.

There’s always a chance that the market could go back up before 21 DTE.

But if there are more than 21 DTE left, then we have three options:

• Option 1: Take the loss. There’s no need to win every single trade. Some trades will turn out to be losers. The study shown above takes losses and it’s still profitable in the long run.
• Option 2: Roll out to the next nearest 45 DTE cycle while keeping the same strike. By rolling out, you extend the duration and give more time for the trade to work out. Furthermore, you can potentially make more as you will be getting an additional credit for rolling out in time.
• Option 3: Roll out to the nearest 45 DTE cycle and to a lower strike price. This way you lower the breakeven point of your trade, and also increase the probability of it working out.

Either of these options is fine.

As long as you do not let any single trade lose more than the max loss of the BPR, you can be profitable in the long run.