There’s no getting around it. The stock market’s historic drop earlier this week all but ensured that some of next month’s expiring put options will be assigned to us. If you are short put options on Harley-Davidson (HOG), Invesco (IVZ), or Western Digital (WDC), it is likely that you will end up being assigned on those contracts (if you have not been already).

Although it is never our intent to get assigned on any of our short put trades, it does happen occasionally. The good news is we are almost always able to recoup our investment by switching to a covered call writing strategy on those positions once their share prices have recovered. That means if you do end up being assigned any of these stocks, you should hold onto them for the time being unless you cannot afford to do so.

In the case of all three stocks, there has been no news specific to the companies to account for their recent declines. The stock market has been selling off, which has been compounded by year-end “window dressing” where poorer performing stocks are unloaded by fund managers so they will not show up as holdings in their annual portfolio tables as of December 31.

For that reason, some of those very same names may enjoy a “January Effect” of being bought up by opportunistic investors next month looking for oversold stocks that could bounce back sharply once the panic selling has subsided. But even if that occurs in 2019, it may not happen in sufficient magnitude to move any of these three positions far enough to get back them above their respective strike prices.

Taking Stock

If you are feeling anxious about the financial implications of being assigned, it may help to keep in mind that in the long run the math really isn’t that much different than not being assigned. When you sell a short put, your broker requires you to have enough cash in your account to cover the trade should it be assigned to you. Being assigned simply means that cash is temporarily transferred into stock, which will eventually return to cash when you sell a covered call against it that is exercised against you.

In that case, it is the element of time that is at work here, which in turn will reduce the annualized return on your money the longer it takes to complete the cycle. When a short put expires out-of-the-money, you immediately have the use of that cash to write a new short put contract. But when that position expires in-the-money and is assigned against you, you will not have the use of that cash to write another short put until that stock is sold.

However, when the underlying stock is assigned to you that means you are eligible to receive any dividends paid while you hold it, and you get to keep any covered call option premiums written against it whether they are exercised or not. While that may not fully offset the opportunity cost of having your cash tied up in the stock, it should still ultimately generate an annual return in excess of an interest-bearing cash account.

What has occurred in the stock market over the past three months is pretty much a worst case scenario for short put sellers. Yet, we were able to close out eight short put positions over that span at a profit without taking a single loss.

Playing the Long Game

That streak will most likely end next month, and if it does then we will focus on recouping any losses by employing a covered call writing strategy on the affected stocks. To illustrate, consider our only open covered call position in The Williams Companies (WMB), a natural gas pipeline company.

We inherited WMB from one of our predecessor services in May of 2017. At that time it was trading near $30. Back in September, while oil prices were still high, I sold a covered call on WMB with a strike price of $29 at a limit price of at least $1.25.

Since then, oil prices have fallen sharply as has WMB’s share price, so that option will most likely expire out-of-the-money next month. That means we get to keep our WMB stock, albeit at a current share price near $21. When oil prices rotate higher (as they inevitably will), I’ll write another covered call option against WMB.

Combined with its trailing annual dividend payment of $1.32, our net cost basis in WMB over the past year has been reduced to about $28. So, if I can write a covered call option on WMB sometime in 2019 at a strike price of $28, whatever option premium I receive at that time plus any additional dividends received in the meantime will be my net profit.

Of course, that will still result in a fairly low ROI on that position but will be a positive return on investment never the less. Point being, if I can squeeze out a modest ROI on my occasional “loser” positions, then my many “winners” should push my average return well above the average performance of the overall stock market.

The key point is not to panic when a stock is assigned to you. We only write puts against stocks that we believe have strong fundamentals which will be realized by the market once the irrational selling has abated. It may take a bit longer than usual to achieve our objective, but that’s what we have to do when the market hits an occasional downdraft as it has this month.