The Money Tree

Safely Generating Income in Retirement

Deep OTM NP Strategy – MAY Week 4

Posted by mounddweller on April 24, 2011

Fellow Traders,

Happy Easter!

We have a total of 7 trades which met our selection criteria, 3 are mid-caps and 4 are small-caps.  Most have shown up on our screen previously at one time or another.  The three exceptions are LIZ, PTIE, and TRGL. 

In running through through the vetting and DD process I use for these type of trades none of the selections jumped out at me as being a great trade.  When these situations occur (and they frequently do) I generally go back to the selections from the prior week and see which, if any, remain viable trade candidates.  Doing so this week returned me to AMSC.  Last week it closed at $12.81 and the $10 strike made our selection criteria.  This week it fell further, closing at $11.74.  The $9 strike has a bid of $0.10.  The $9 strike is also less than the $9.86 book value of AMSC.

Up above I referenced the vetting and DD process I use for my Deep OTM NP Strategy trades.  It is relatively quick.  I focus in two primary areas, (1) the one-year price chart of the underlying stock, and (2) that company’s most recent financial statements.

On the 0ne-year price chart I look at a few items, the 52-week hi and low, areas of previous price support, and where the current price is relative to the first two items.  I use these items to help me ascertain if now is a good time to trade the stock.  Stocks that are closer to their 52-week lows than their highs interest me.  Right or wrong I believe they have less distance to fall before value investors step in and begin buying the stock.  I also like selections where the strike price is below areas of previous support.    

On the company’s financial statements I look at profitability, cash flow, and net cash.   Trades where the underlying company is profitable, or at least generating positive cash flow generally rate higher than those that don’t.  If the company is neither profitable or generating positive cash flow then the amount of cash on the balance sheet takes on great importance.

I believe the first set of criteria help me pick trades that will expire OTM.  The second set of criteria are important for when I’m wrong about the trade.  If I can’t extricate myself from a losing trade prior to expiration and I end up having a stock put to me, I want to feel comfortable having it in my portfolio for some period of time.



6 Responses to “Deep OTM NP Strategy – MAY Week 4”

  1. Vijay Madnani said

    Aloha Troy,
    I have been following your blog for a few days with interest. I have a couple questions, if I may please:
    a) where can i find the definition of Put Factor ?
    b) Does it make sense to consider deep OTM Puts on LEAPS ?

    I apologize if the questions above are elementary; but i sure would like your take on these. THX>>>

  2. mounddweller said


    I am happy to answer your questions. Put Factor (PF) is a proprietary formula developed by Ron Groenke. Since it is a proprietary formula I don’t feel comfortable posting it here on my blog. However, Ron gives you the formula in his book, “Show Me the Money”. His book can be purchased on Amazon and is very reasonably priced. FYI: I receive no compensation for plugging Ron’s book.

    I can tell you what the basic elements are that go into calculating PF. They are as follows:

    (1)The number of days to expiration,
    (2)The amount of the premium to be earned by selling the put option,
    (3)The total discount which is the premium plus the difference between the stock price and the strike price
    (4)The current stock price.

    Now regarding your other question, I would say yes, it does make sense to consider deep OTM puts on LEAPS. However, I would not use the selection criteria that I use in my current strategy to execute such a trade. The stocks that meet my current selection criteria are NOT suitable for holding for an extended period of time. They are very risky. You are more or less betting that the stock won’t fall far enough or fast enough for you to get caught ITM at expiration.

    Here’s how I would approach doing a Deep OTM NP trade with a LEAP. I would look for out of favor blue chip stocks and then sell LEAP puts on them at a strike price and premium that met my minimum return on invested capital requirements.

    Just for the sake of discussion let’s consider the JAN ’13 $22.50 put on MSFT. MSFT closed today at $26.38. It, as well as INTC and CSCO, have been out of favor in the market for some time now. You can sell the $22.50 put for $2.11. Doing so would give you a 9.37% ROIC with about 20 months to expiration. At the break-even point of $20.39 your Downside protection (DSP) would be 22.7% from today’s closing price.

    The questions to be answered then become

    (1) Would I be comfortable owning MSFT at $20.39 regardless of the market price in January 2013,
    (2) Is 9.37% ROIC with a 20-month holding period a satisfactory rate of return,
    (3) Is there another trade that has a better risk/reward profile with the same or shorter holding period?

    NOTE: the MSFT trade is NOT a recommendation, I used it purely for illustrative purposes.

    Hope this helps.


  3. Vijay said

    Aloha Troy,

    Thank you so much for your detailed explanation and insights. I will go ahead and purchase Ron’s book, as suggested.
    As a side, I have been using the delta or probability of ‘being put’ as my selection criteria and that has served me well. For example, the MSFT Jan 13 22.5 Put has a probability of .27. So this does not meet my comfort level, which is < .20. The jan 13 20 strike has a prob. of .19 and I would go for this instead. However, the premium is around 1.30 and so I would probably look for some other stock to get into. Anyways, this is just a 'newbie' technique; but it sure has kept me out of trouble (albeit, i got creamed on CCME because they went bust.. here the probability did not help).
    Thank you once again for your guidance and suggestions. I look forward to your upcoming posts…


    • mounddweller said


      You’re welcome. I have another investing buddy who also uses the delta to screen his NP trades. He has an excellent screener on his web-site, You have to be a paid-member to use the screener but it is reasonably priced. I can’t post a screen-shot of his site in my comments but I will post a message on my blog about his site and insert a screen-shot of his screener so you can get a feel for how it works.


  4. Vijay said

    Aloha Troy,

    Thank you for your rapid response and the link to MTR. I looked at the website and it has definite possibilities. I suppose one way to find out is to subscribe which I intend to. Incidentally, have you heard or seen this site: ?? I hear good reviews from my trading friends. It seems to have good scanning capabilities based on several search criteria. I understand they have a 2 week free tiral as
    Finally, besides looking a delta, I also look at charts and look at the S/R of the stock for the last 5 years, as also it’s earnings history (from and Yahoo finance). I am anxious to run the scan on MTR and see if I can net a few good candidates and paper-trade these for a few weeks. Thanks for all your help.


  5. Vijay said

    Prior note : end of first paragraph… ‘ I understand they have a 2 week trial as well.’

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