Although you can effectively model the P&L of 30 days 'til expiry at-the-money short puts, it's difficult to model "the other stuff" a trader would typically do with a short put that is in the money toward expiry (i.e., take assignment, roll out "as is," roll out for strike improvement, etc.). (At least, I don't have access to that kind of model or can't easily program one without breaking my brain).
You can, however, run a small number of occurrences (relatively speaking) to see how the setup would work in practice, so that you can have expectations as to how much the at-the-money 30 day short put pays over time, as well as the frequency of assignment and/or ending up with an in-the-money that has to be managed. You'd naturally have to run this for months to get any decent idea of how the setup would perform over a larger time frame. (Most studies actually look at selling a given strike in expiries of a given duration on a daily basis, which would be a lot of spreadsheet).
The basic rules:
1. Sell the at-the-money short put nearest 30 days until expiry.
2. Either close out the short put on approaching worthless (e.g., <.20) or run to expiry if in-the-money.
3. If assigned on any given short put, initially sell the 30 days until expiry call at the strike at which you sold the short put, looking to exit the resulting covered call at a profit.*
4. Since not everyone has "infinite cash," I'll assume a maximal deployment of 5 lots. As you can see by the chart, you can contemplate getting stuck in a particular rung or rungs for a lengthy period of time, reducing cost basis via rolls of the short call until you're able to exit that "leg" profitably or at break even. The ROC becomes almost immediately "less sexy" when that occurs, since that will potentially be "dead buying power" for weeks (and potentially months) at a time.
5. It's probably to one's advantage to have additional rules as to when and when not to pull the trigger on a given rung (i.e., implied volatility rank and 30-day implied), but for the sake of simplicity, I'm not setting out that type of rule here.
Pictured here would be the first leg, at the 47 strike in the May 13th expiry, paying 4.25 at the mid, with a resulting cost basis of 47.00 - 4.25 or 42.75 if assigned shares on the 47 short put.** For purposes of the return on capital calculation, I'm operating on the assumption that the short put will be cash secured,*** which means you'll tie up 42.75 of buying power to put this on, with the resulting ROC of 9.94% at max (implying a finish above the short put strike at expiry or the ability to pull off the short put on approaching worthless prior to that).
* -- In practice, this isn't what I do when confronted with an in-the-money short put at expiry. I look at (a) taking assignment; (b) rolling out the short put as is to varying durations; and (c) rolling out the short put with strike improvement to varying durations. I then compare and contrast what I would get for each in credit and generally opt for the choice that would result in the largest cost basis reduction. For example, I'm not going to take assignment to sell a call against for less credit than I could get by just rolling the short put out for duration.
** -- It doesn't look like you get much buying power relief on margin anyhow, at least with my broker. The buying power reduction for the 47 short put on margin appears to be 35.26 -- 75% of the short put strike. It's something, but not the typical relief you get on margin, which is about 20% of the short put strike. That being said, 4.25 on buying power effect of 35.26 is 12.05% at max -- a smidge sexier than cash secured.
*** -- I can also see a potential additional rule or rules that takes profit between 42.75 (your break even) and 47.00 toward expiry as extrinsic in the 47.00 converges on 0 or potentially rolls out the 47 to a 30 day at-the-money strike when it's in profit. On a practical level, I tend to do this quite a bit, but it's involves rolling from an out-of-the-money strike to an out-of-the-money strike, which continues to leave leave me with room to be wrong.
You can, however, run a small number of occurrences (relatively speaking) to see how the setup would work in practice, so that you can have expectations as to how much the at-the-money 30 day short put pays over time, as well as the frequency of assignment and/or ending up with an in-the-money that has to be managed. You'd naturally have to run this for months to get any decent idea of how the setup would perform over a larger time frame. (Most studies actually look at selling a given strike in expiries of a given duration on a daily basis, which would be a lot of spreadsheet).
The basic rules:
1. Sell the at-the-money short put nearest 30 days until expiry.
2. Either close out the short put on approaching worthless (e.g., <.20) or run to expiry if in-the-money.
3. If assigned on any given short put, initially sell the 30 days until expiry call at the strike at which you sold the short put, looking to exit the resulting covered call at a profit.*
4. Since not everyone has "infinite cash," I'll assume a maximal deployment of 5 lots. As you can see by the chart, you can contemplate getting stuck in a particular rung or rungs for a lengthy period of time, reducing cost basis via rolls of the short call until you're able to exit that "leg" profitably or at break even. The ROC becomes almost immediately "less sexy" when that occurs, since that will potentially be "dead buying power" for weeks (and potentially months) at a time.
5. It's probably to one's advantage to have additional rules as to when and when not to pull the trigger on a given rung (i.e., implied volatility rank and 30-day implied), but for the sake of simplicity, I'm not setting out that type of rule here.
Pictured here would be the first leg, at the 47 strike in the May 13th expiry, paying 4.25 at the mid, with a resulting cost basis of 47.00 - 4.25 or 42.75 if assigned shares on the 47 short put.** For purposes of the return on capital calculation, I'm operating on the assumption that the short put will be cash secured,*** which means you'll tie up 42.75 of buying power to put this on, with the resulting ROC of 9.94% at max (implying a finish above the short put strike at expiry or the ability to pull off the short put on approaching worthless prior to that).
* -- In practice, this isn't what I do when confronted with an in-the-money short put at expiry. I look at (a) taking assignment; (b) rolling out the short put as is to varying durations; and (c) rolling out the short put with strike improvement to varying durations. I then compare and contrast what I would get for each in credit and generally opt for the choice that would result in the largest cost basis reduction. For example, I'm not going to take assignment to sell a call against for less credit than I could get by just rolling the short put out for duration.
** -- It doesn't look like you get much buying power relief on margin anyhow, at least with my broker. The buying power reduction for the 47 short put on margin appears to be 35.26 -- 75% of the short put strike. It's something, but not the typical relief you get on margin, which is about 20% of the short put strike. That being said, 4.25 on buying power effect of 35.26 is 12.05% at max -- a smidge sexier than cash secured.
*** -- I can also see a potential additional rule or rules that takes profit between 42.75 (your break even) and 47.00 toward expiry as extrinsic in the 47.00 converges on 0 or potentially rolls out the 47 to a 30 day at-the-money strike when it's in profit. On a practical level, I tend to do this quite a bit, but it's involves rolling from an out-of-the-money strike to an out-of-the-money strike, which continues to leave leave me with room to be wrong.
Trade active:
Opened: TQQQ May 20th 41 short put, 4.22 credit, cost basis of 36.78 if assigned. It's now two rungs: the May 13th 47, with a cost basis of 42.75, and the May 20th 41, with a cost basis of 36.78.
Trade active:
Leg Three: May 27th 40 short put, 4.15 credit, cost basis of 35.85 if assigned.
Trade active:
Leg Four: June 3rd 34 short put, 4.30 credit, cost basis of 29.70 if assigned. Ladder up to this point: May 13th 47; May 20th 41; May 27th 40; June 3rd 34. You can easily see how things can get out of hand in a market that is trending against you for even a short period of time.
Trade active:
Leg Five: June 10th 28 short put, 3.50 credit, cost basis of 24.50 if assigned.
Trade active:
Leg 1: May 13th 47 Short Put. Here would be my ordinary decisional tree on this: (a) Take assignment; sell the 43 call against, which would be slightly above my cost basis. Unfortunately, the 43 short call nearest 30 DTE is only paying .19 ($19) at the mid, so I'd have to sell something farther out in time to get "paid decently." (b) Roll out "as is" to the expiry nearest 30 days. A roll from the May 13th 47 to the June 10th 47 is paying .46 ($46) at the mid. (c) Roll down and out for a credit. The shortest duration that I can both strike improve and receive a credit is currently the September monthly, where I'd receive .41 at the mid for a strike improvement to 46. (d) Sell a call against, but below my cost basis. I generally only do this as a last resort where price has pulled away from where I'd ordinarily sell call against in shorter duration or where I'd have to go out an ungodly duration to get paid something decent.
Since this is "just a model" with specific rules, we're going to assume we take assignment and will sell a 30 DTE call at the short put strike at which we originally sold our put, which will not be paying jack diddly here in the short term. This, in fact, is why it's so hard to model "the wheel," since at given junctures you have quite a large set of choices to make involving credit received, duration, and strike. It's not necessarily as simple as "do this particular thing every time," which I kind of my point in doing this little exercise here.
Since this is "just a model" with specific rules, we're going to assume we take assignment and will sell a 30 DTE call at the short put strike at which we originally sold our put, which will not be paying jack diddly here in the short term. This, in fact, is why it's so hard to model "the wheel," since at given junctures you have quite a large set of choices to make involving credit received, duration, and strike. It's not necessarily as simple as "do this particular thing every time," which I kind of my point in doing this little exercise here.
Comment:
There is actually one additional decisional choice that people don't often look at: take the loss, move on. Here, it would be the difference between your cost basis in Leg 1 (42.75) and the price at which TQQQ finishes at expiry. Currently at 1 DTE, the 47 short put that was sold for 4.25 is now worth 18.65, so you'd be taking a 14.40 ($1440) loss.