PUT Spreads....

On 7/21/2011 I sold my first PUT spread.
PEP was selling for ~$65.50 when the order filled.
Sold PEP Jan2013 $57.50 for $3.39
Bought PEP Jan2013 $50.00 for $1.70.

I've decided to use PUT Spreads when creating long term PUT positions to limit the EA (Exposure Amount).   With this limited exposure, I'm using a Delta limit of 30 (-.30) (versus 20 for naked PUTs) as my sold PUT limit (OK, the PEP one was 31, more likely 30.1 as I always  round the Delta UP).

I'm computing the CAGR as   (EA/(EA-UPG)^(1/(Days/365))-1   or  (7.5/(7.5-1.658)^(1/(548/365)-1.  Note: 1.658 is difference in $3.39-1.70 net of commissions.

This computes to an 18.1% CAGR.

While this computes correctly, I'm not sure I'm willing to create a total exposure amount equivalent to my naked PUT exposure using spreads to increase my total return.   I'll likely tread slowly here.  

I've contemplated adjusting the Exposure Amount computation for naked PUTs to 50% of the actual EA as this seems to me to be a reasonable 'black swan' price drop amount.   All of this will take some additional contemplation. 

What is the real exposure amount for selling only a naked PUT? Theoretically it is 100% of the PUT strike price, but is that reasonable for a stable company like ABT? I think not. So what should we use as the basis for computing returns? I think the 'black swan' can answer the question. We have several recent examples:


MRK: In 2004 MRK's drug VIOXX was pulled from the market resulting in a 45% drop in the stock price over just a few days.

BP: In 2010 BP's Gulf oil spill sent the stock down nearly 60%.

BAC: (and others) down 95% from Oct 2008 to March 2009. Rallied to only a 60% loss by July 2009, now at nearly 90% loss. I'm sure the JPM and WFC numbers are better that BAC's. Of course BAC's are better than some others.

On balance looks like 50% of the stock price is a reasonable number to use to compare the returns of a naked put versus a spread.  Still contemplating the change.