As I discuss in the leverage section, I focus on leveraging investment returns though the sale of long dated options. I only sell options on stocks that I would be comfortable owning at the strike price. I do not focus on selling far out-of-the-money options for two reasons. First, if I were to sell a put with a strike price that was much below the current price, the drop that would be required to reach the strike price (and thus be assigned) would likely only be caused by a material event or change in the business. If that were to happen I may not be comfortable with the company at that price and I would want to liquidate the position. Second, the yield on the capital at risk is very low and akin to “picking up nickels in front of a steam roller”. Low and moderate changes in the underlying can create much larger swings in the derivative given the high levels of gamma in deep out-of-the-money options.
In my portfolio, I target to sell options that have at least a 10% initial yield on the capital that is put at risk. For example, if I were interested in selling puts on ACME Corp. (given I like the underlying business and feel that the Company is both undervalued and has limited risk to their business model), I would sell a $75 put for no less than $7.50 in premium. The profit target for closing short options is when they yield less than 5% on the capital at risk. In the same example, I would purchase back the short ACME puts if the premium to do so fell below $3.25 per put. If I still like the Company, I can extend the expiration date to meet the entry requirement (10% yield) or increase the strike price.
For a list of my current short puts, see my portfolio positions.