Tik-Tok trades explained — Selling cash-secured puts the trade that bankrupted a Hedge Fund Manager

Tik-Tok is a great app. It is my favorite social media. If I had any camera talents, I would totally try to beat Bella Poarch.

Yet, there’s one recent trend that is triggering me like no other thing around.

Teenagers explaining the stock market.

Why so? Old dude…

Ok, ok, there’s nothing wrong with young ones explaining to others, the trade. In fact, it is more of a blessing than a curse. Videos like this one make people interested in investments, just what is needed to finally make investments mainstream.

But when it comes to getting rich schemes, Tik-Tok is booming with faulty, incomplete, and arguably dangerous advice; here is an example:

Selling cash-secured puts

Where do I even start? 🤯

So the whole idea of earning passive income is to invest in something and let that something steadily give you a recurring return through time. Bonds are the original passive income. You get coupons out of owning them. Stocks also deliver passive income through dividends. But if nothing of these makes sense to you, then the video above will lure you into a false sense of security.

The trade:

• You have cash in your trading account. 😃
• You sell a put on a stock like Disney. 🤨

Each put has a strike price, a maturity (expiry date), and a premium price (the current put price).

Today January 14th, 2021, Disney trades at USD 176 per share.

You can sell a put let's say at the170 strike price, with expiration on January 22th, 2021, for about USD 1.10, and since all options are bundles of 100 shares, you receive 110 USD dollars (1.10 x 100) for selling one put.

Nice! So far, so good! Tik-Tok is making me money, baby!

Possible future scenarios

Where the Disney stock is on January 22th, matters:

If the stock price is higher than the strike price: Above 170, you keep the “premium” the 110 dollars and the option you sold, expires worthless. Sweet!

Any price below $170 and you are forced to buy Disney shares at 170, and not a small amount, 100 of them. So, USD 170 x 100 shares = USD 17,000, but hey, you still keep the premium.

So let's say that on Monday, Disney’s stock is at $165. You sell your 100 Disney shares, realizing a loss of ($165–$170) x 100 = -500 that is somewhat sweetened by the +110 dollars from selling the put.

To summarize:

• If the stock is above the strike level, you keep the premium.
• If the stock is below, you buy the share at the strike price and incur a loss.

A chart always helps.

No matter how high Disney goes, you always earn $110. In contrast, if it goes down, well. I don’t know about you but I would rather be on the side of “bounded losses with great upside potential”

Last thoughts

There’s no real free lunch out there. This strategy works when the market is going nowhere or upwards. But then again, if the stock is going upwards, why don’t you just, buy it?

This strategy generally explodes, just like this guy discovered, losing everything even before most of the Internet Trading buzz existed. Arguably he was being even more risky selling puts without having enough cash to buy the stocks. At least our Tik-Tok friend got a slightly less dangerous variant of the idea.