Should you sell "sloppy seconds?"

In this post, I explore the opportunity to sell 0 DTE options with >99% Probability of Profit. This means selling short puts or covered calls very deep Out-of-the-Money (OTM). Typically, this entails offering up your own buying power in exchange for a very small (<$10) compensation. Is it worth it?

Despite this being a seemingly silly move, I am sure I am not the only one who has considered selling a couple of absurdly OTM options in exchange for lunch money.

Who is buying a 20% OTM put from you with 5 hours until expiration? Likely someone who sold the put prior and is trying to buy it back early so they can use their buying power elsewhere. 

tl;dr: If you have extra buying power (on margin) that you do not intend to use, this is a viable strategy that can also assist with your gambling addiction. However, I recommend only doing this if you would actually take assignment if the stock does indeed move sharply against you. Do NOT do this with covered calls on a stock you intend to hold forever. Do NOT do this with short puts if you do not have the margin allowance to take assignment, even if you have the buying power.

Consideration: I am not necessarily advocating for this strategy for most portfolios. However, I have used it in the past to pull some beer money for either reinvestment into cheap dividend stocks like ET, NLY, and NYMT. Consider your risk tolerance and how much you want some extra cash.

What are sloppy seconds?

In the context of options trading, "sloppy seconds" refers to selling a nearly useless call or put with very little time until expiration, usually measured in hours, for modest compensation. The term is derived from the idea that the person buying a 20% OTM put with hours until expiration is likely someone who sold this put a long time ago, and is buying back their put for a large gain. They do not intend to wait for expiration because they want to use their buying power now, and so they release themselves from their collateral requirement by buying back a useless contract early.

You, as the seller of that contract, are trading your buying power for the remaining, ravaged value on that contract. We are taking the sloppy seconds on their short call or put.

The above options chain shows an example. At the time of this screenshot, AMZN puts at a strike >10% OTM and 5 hours until expiration are being bid at $10. Someone likely intends to buy back their short put for a gain and would like to find someone who will sell it to them. 

For $10, the seller would be agreeing to buy 100x shares of AMZN at $2,980 if the stock falls below that price within the next 5 hours. Is it worth it?

Should we sell sloppy seconds?

It is enjoyable to sell these contracts to pick up some loose change, and it can also be fun. We should not discount the value of getting an extra $10/week every Friday to buy a 6-pack of cheap beer. But obviously, there is considerable risk to this strategy. 

Although it is exceedingly likely that you can realize max profit on such a contract, Black Swan events do happen. We are picking up pennies in front of a steamroller. I would recommend only using this strategy only if you meet BOTH of the following conditions, which reduce the weight of that steamroller:

1) You do not intend to use the buying power elsewhere. If you have $100k in leftover margin buying power that you have no interest in using on a longer-term play, then picking up $10 instead of $0 is reasonable. Keep in mind you will probably only do this with a margin account where buying power requirements are reduced vs cash accounts. You must be mindful of actual cost of shares in the next bullet.

2) You would be willing to take assignment: If you would be happy to pick up shares of AMZN below $3,000, then the risk of assignment is acceptable. If you do not like the stock, do not sell sloppy seconds. Likewise, if you are using this strategy with covered calls instead of short puts, then make sure you would actually be willing to sell shares at the strike. Do NOT sell puts if your margin allowance would not cover the cost of 100x shares, even if your broker will allow you the buying power to sell a naked put.

How do we find someone willing to buy?

Most brokers will allow you to comb through the options chain and easily identify bid/ask, volume, and open interest on one screen. Choose a high-volume stock and scroll at least 10% OTM and search for bids.

GOOGL's $2,400 put stands out. There is ~0% chance that GOOGL falls an additional 11% today. Yet, someone is willing to give you between $5 and $10 to put your buying power up as collateral. 

Notice that there is no bid on the other strikes except for the $2397.50. However, there are asks at every strike. Although people are willing to sell these other strikes, no one will buy them. The sloppy seconds trader must identify these OTM strikes with bids in order to identify places where he can get a fill. Volume also matters. If there is very little volume, it will be very difficult to get a fill except at the bid.

Keep in mind that by noon on expiration day, bids drop to $1 at 10% OTM strikes. Selling these puts is not worth the time spend entering the order, and any commissions would ruin the worth of the contract.

Notice that there are no bids on 0 DTE SHOP puts at low strikes. The asks will not be filled, and entering limit orders below the ask likely will not yield results because there is no daily volume.

What is the risk?

It is not unheard of for a stock to move 10% or more in one afternoon. If bad news comes out about the company, then your 10% OTM short put could wind up ITM and you would be forced to buy shares. This is why it is very important to ensure you have the marginable cash available and a willingness to buy shares if the stock does indeed fall below your short put's strike.

I can think of worse things than buying AMZN below $3,000. But keep in mind that if a stock drops 10% at 1:00 on Friday, there is probably a reason. That reason could change your view of the stock, which may may you less willing to buy AMZN at $3,000 after the news breaks. 

Likewise, if you sell a covered call 10% OTM, you can still find it assigned. You will have profited, but if you are unwilling to sell those shares, you will eat a loss on the short call. And again, if your stock rises 10% in less than a day, there is a reason. And that reason could make you more desirous of holding shares than you are now.

Final Thoughts: 

1) Make sure there is no earnings happening after hours. A 15% move is more likely if earnings is happening after hours.

2) Bids drop rapidly by noon because the Greek Charm kicks in. Charm will crush OTM contract premiums in the final hours.

3) Seriously consider if this is worth it for you before executing. If you have $400,000 of buying power left over on a Friday like I do, then this is okay. If you have $20,000 of margin buying power, please do not use it to sell short puts that would put you underwater if assigned. It is not worth the $5.

4) Remember that you are not "risking $300k for $5." You are risking the obligation to buy shares at the strike. You are not actually going to lose all of your collateral unless the stock falls to $0. This is the same risk you carry when you buy shares outright.