A Diversified Uncovered Writing Approach

H

highseas

Hi all, I'm new to Elite Trader, though I have been trading options for three years now (on and off, ramping up recently). Predictably I started with long calls and shorts. More recently I'm into credit spreads and uncovered writing.

I understand the argument that you'll have a lot of small winners, only to be dwarfed by a big losing trade. Can the adverse effects be mitigated by selling uncovered calls and puts (and sometimes short strangles) (1) when they are way out of money and (2) when you diversify by having different stocks, different strike prices, with positions established perhaps on different days so as not to be too exposed to the prices of one day? (I mostly just do short term options--less than 20--so time works its magic faster).

Now, the above concerns the mitigating steps at the outset. As time moves along and new developments happen, can't preventive steps be taken to minimize losses? Let's say you sold a put and news came out and the stock moves down big time, and IV spikes too, so your short put gets killed both ways. Now, with the IV spike, the put prices will be way up, can't you close out your short put and sell a still lower put. This could result in a reduced loss if the new short put expires worthless.

Also, when I'm talking about "way out of the money", think GS now, at $145 or so. I'm talking about selling a May 90 or 95 put, or DNDN a few days ago, at $40, and selling the $15 puts. If you don't put all your eggs in the GS or DNDN basket, and you do the same way out of the money writing with a bunch of stocks, calls and puts, can it work consistently?

Thanks in advance for any helpful comments.
 
there's always some risk. If you could short options with no risk, you wouldn't get any premium. If you sold a 150 put on GS a couple of weeks ago, you wouldn't have thought then that the stock would fall 20% putting you ITM.

It's a great strategy, but you have to be watchful, and ready to take serious losses in MAC events.
 
I'm seeing a difference in mindset from some posters here. danshirley said it well, I don't just buy a stock or an option as a vehicle to increase wealth- it has to be a good company. This is why I have more of a leaning towards being long the stock. Good input from everyone though, thanks.
 
Quote from highseas:

I understand the argument that you'll have a lot of small winners, only to be dwarfed by a big losing trade. Can the adverse effects be mitigated by selling uncovered calls and puts (and sometimes short strangles) (1) when they are way out of money and (2) when you diversify by having different stocks, different strike prices, with positions established perhaps on different days so as not to be too exposed to the prices of one day? (I mostly just do short term options--less than 20--so time works its magic faster).

Now, the above concerns the mitigating steps at the outset. As time moves along and new developments happen, can't preventive steps be taken to minimize losses? Let's say you sold a put and news came out and the stock moves down big time, and IV spikes too, so your short put gets killed both ways. Now, with the IV spike, the put prices will be way up, can't you close out your short put and sell a still lower put. This could result in a reduced loss if the new short put expires worthless.
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Everything involves trade offs. The more OTM the strikes are that you sell, the lower the probability that they'll be hit. In return, the premium received is less and the larger the number of them it will take to offset the loss if you get that ONE bad sell that eats you up.

Diversifying among stocks reduces the portfolio exposure from bad news in a single issue.

I don't think much of selling options on different days to reduce price exposure on any given day. I'd lean more to establishing positions when price looks favorable and diminishing risk by converting to spreads (vertical, calendar, condor, etc.) when price moves favorably. You can then build larger positions (hedged) by scaling in if price oscillates.

Rolling losing naked options more OTM is a difficult if not a losing proposition unless the stock eventually levels out/bounces. For puts, as price drops and IV increases, the higher short strike gains a lot more (your loss) due to a higher delta than the OTM and is a disaster for rolling if it gets ITM. All of this is mitigated somewhat if you've gotten some time decay but that's secondary to price.

As always, it comes down to timing, selection and money management which is a lot easier said than done.
 
Quote from highseas:

Hi all, I'm new to Elite Trader, though I have been trading options for three years now (on and off, ramping up recently). Predictably I started with long calls and shorts. More recently I'm into credit spreads and uncovered writing.

I understand the argument that you'll have a lot of small winners, only to be dwarfed by a big losing trade. Can the adverse effects be mitigated by selling uncovered calls and puts (and sometimes short strangles) (1) when they are way out of money and (2) when you diversify by having different stocks, different strike prices, with positions established perhaps on different days so as not to be too exposed to the prices of one day? (I mostly just do short term options--less than 20--so time works its magic faster).

Now, the above concerns the mitigating steps at the outset. As time moves along and new developments happen, can't preventive steps be taken to minimize losses? Let's say you sold a put and news came out and the stock moves down big time, and IV spikes too, so your short put gets killed both ways. Now, with the IV spike, the put prices will be way up, can't you close out your short put and sell a still lower put. This could result in a reduced loss if the new short put expires worthless.

Also, when I'm talking about "way out of the money", think GS now, at $145 or so. I'm talking about selling a May 90 or 95 put, or DNDN a few days ago, at $40, and selling the $15 puts. If you don't put all your eggs in the GS or DNDN basket, and you do the same way out of the money writing with a bunch of stocks, calls and puts, can it work consistently?

Thanks in advance for any helpful comments.
More...

the biggest risk reducing step you can make in premium selling is to eliminate specific stock risk. you do that by not selling premium on individual stocks. if you sell options on indexes or etf's you will not wake up with a gs or bp situation if you are short puts or a buyout if you are short calls.
 
good points.


Quote from spindr0:

Everything involves trade offs. The more OTM the strikes are that you sell, the lower the probability that they'll be hit. In return, the premium received is less and the larger the number of them it will take to offset the loss if you get that ONE bad sell that eats you up.

Diversifying among stocks reduces the portfolio exposure from bad news in a single issue.

I don't think much of selling options on different days to reduce price exposure on any given day. I'd lean more to establishing positions when price looks favorable and diminishing risk by converting to spreads (vertical, calendar, condor, etc.) when price moves favorably. You can then build larger positions (hedged) by scaling in if price oscillates.

Rolling losing naked options more OTM is a difficult if not a losing proposition unless the stock eventually levels out/bounces. For puts, as price drops and IV increases, the higher short strike gains a lot more (your loss) due to a higher delta than the OTM and is a disaster for rolling if it gets ITM. All of this is mitigated somewhat if you've gotten some time decay but that's secondary to price.

As always, it comes down to timing, selection and money management which is a lot easier said than done.
More...
 
Thanks for the replies and the many good points so far. I also like spreads but sometimes a really high probability spread has razor thin profits (especially after commissions). I still do spreads at times. (For these reasons, I like iron condors in principle, but rarely employ them).

I've also thought of (and written options against) index ETFs. It is a good strategy and probably less risky, though the profits are also reduced accordingly.

I have to say, though, that having hedged positions lets you sleep much more soundly. You don't have to worry too much about huge, sudden, moves against you.
 
Quote from highseas:

Hi all, I'm new to Elite Trader, though I have been trading options for three years now (on and off, ramping up recently). Predictably I started with long calls and shorts. More recently I'm into credit spreads and uncovered writing.

I understand the argument that you'll have a lot of small winners, only to be dwarfed by a big losing trade. Can the adverse effects be mitigated by selling uncovered calls and puts (and sometimes short strangles) (1) when they are way out of money and (2) when you diversify by having different stocks, different strike prices, with positions established perhaps on different days so as not to be too exposed to the prices of one day? (I mostly just do short term options--less than 20--so time works its magic faster).

Now, the above concerns the mitigating steps at the outset. As time moves along and new developments happen, can't preventive steps be taken to minimize losses? Let's say you sold a put and news came out and the stock moves down big time, and IV spikes too, so your short put gets killed both ways. Now, with the IV spike, the put prices will be way up, can't you close out your short put and sell a still lower put. This could result in a reduced loss if the new short put expires worthless.

Also, when I'm talking about "way out of the money", think GS now, at $145 or so. I'm talking about selling a May 90 or 95 put, or DNDN a few days ago, at $40, and selling the $15 puts. If you don't put all your eggs in the GS or DNDN basket, and you do the same way out of the money writing with a bunch of stocks, calls and puts, can it work consistently?

Thanks in advance for any helpful comments.
More...

There is money to be made since the premiums on writing options tend to exceed the historical volatility. But actually getting access to those profits is extremely hard. It can't be the primary strategy in your portfolio - it has to be just a tiny side line. The reason is that your positions must be TINY in order to protect yourself from a 1987-type event. And no, diversification of ticker, strike and expiration won't help you. The whole market can move and is all highly correlated. The only way to write uncovered options correctly is to keep your position size way down.

Since the bid/ask gaps in options are so huge, you pretty much have to open your positions via making a market. Otherwise you'll take a bath.

Writing uncovered options is really a game for firms with 9 figure bankrolls so they can take a max risk of a few % of the bankroll and still have meaningful position sizes and justify someone spending all their time dicking around with it.
 
Quote from highseas:

Thanks for the replies and the many good points so far. I also like spreads but sometimes a really high probability spread has razor thin profits (especially after commissions). I still do spreads at times. (For these reasons, I like iron condors in principle, but rarely employ them).
More...
The profits are a bit "thicker" if you leg in (bear in mind that it's a NP strategy from the get go so legging in is a secondary decision).

If you're lucky enough to be playing with an underlying that bounces around in a short time period (possibly even intraday), you can add the long leg after a modest rise. If it drops back to the original level, sell some more naked puts. Wash, rinse, repeat.

The counter argument is that if you have a bounce and a gain, take it and find another sand box to play naked put in.
 
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