Are naked puts really this safe????

[dmo]

Quote from riskfreetrading:

Very good post! Thanks. Did you try to use this in stock earnings (before/after)? What do you think. Thanks

Never tried it that way. But it might work that way in an option contract with really tight penny spreads. Try it and let us know!

 

[beep1]

Quote from dmo:

If the S&P is at 1200, you can hedge your stock portfolio by buying 1100 puts, or by selling 1300 calls. Either way, it will contribute to the SPX skew looking as it always does - with the 1100 strike trading at a higher IV than the 1300 strike.

Of course, you can buy 1300 puts, and you can sell 1100 calls, which would have the opposite effect on the skew. But such trades are a small minority. If you compare the volume at the strikes higher than 1200 (ATM in our example), at each strike more calls trade than puts - and the higher you go, the more lopsided that is. If you look at the strikes below 1200, more puts than calls trade at each strike - and again, the lower you go, the more lopsided that ratio is.

In other words, DITM volume is small compared to OTM volume, and therefore is a small factor in shaping the skew.

thank you for taking the time to provide detailed answers. i appreciate it. If I can comment on what you wrote, I would add that if one hedges with DITM options, the needed volume should be lower as the DITM deltas are higher (in absolute value) compared to OTM options. I am therefore wondering to what extent this point I raise here reduces the strength of your argument. thanks for your intense contributions.

 

[Nanook]

Quote from dmo:

The ideal premium-neutral position is to be long the wings and short the middle. That way, if volatility goes up, you become long vegas and make money. If volatility goes down, you become short vegas and make money. Sounds strange but it's true. Try it and you'll see. It's one of the reasons for the classic "smile" of volatility. And if you get those 10-sigma moves, you'll make nothing but money.

Discussed on this ET thread: http://www.elitetrader.com/vb/showthread.php?s=&threadid=24449&perpage=6&pagenumber=1

 

[bone]

"Beating" and "DMO": you're smart cookies. That's why NOBODY will sell you a strangle in the OTC power market. At least, the price will be considerably more than modeled FV.

 

[dmo]

Quote from beep1:

thank you for taking the time to provide detailed answers. i appreciate it. If I can comment on what you wrote, I would add that if one hedges with DITM options, the needed volume should be lower as the DITM deltas are higher (in absolute value) compared to OTM options. I am therefore wondering to what extent this point I raise here reduces the strength of your argument. thanks for your intense contributions.

I think you're raising the question of the most sensible way to hedge, and wondering if the way it is commonly done - with OTM options - really makes more sense than doing it with DITM options.

It's a worthwhile discussion, but for purposes of understanding the skew I think it's more important to know what people are actually doing. Did you see the graphic I attached to a post a few pages ago? It shows clearly that a lopsided majority of volume at each strike is the OTM over the ITM. So whether it makes sense or not, the majority of put buyers are buying the lower strikes, and bidding up the volatility down there in the process.

 

[atticus]

Wings were meant to be bought.

 

[atticus]

The skew is demand-driven for the extrinsic premium. Nobody is bidding deep itm index calls out of demand; causation is the demand for OTM puts and parity which keeps strike-vols in-line. IOW, nobody is buying cheap-vol in guts as the vol is bid in pennies/intrinsic. There is ZERO flow in deep itm calls.

 

[MasterAtWork]

Quote from dmo:

Well of COURSE the skew is related to supply and demand. That's ALL the skew is. It is a living, breathing indicator of the supply/demand for options at lower strikes vs. the supply/demand for options at higher strikes.

Since the vast majority of options that trade at lower strikes are puts and the vast majority of options that trade at higher strikes are calls, the skew is a direct reflection of the supply/demand for puts vs the supply/demand for calls. That's it. It is nothing else.

.....

So why are option traders so much more anxious to buy puts than calls? Again, "portfolio insurance." I can't prove anything past this point, but it just seems obvious common sense that a huge majority of people are net long stocks - far more than are net short stocks - and that accounts for the greater demand for puts as protection.

There's a little more to it than that but I have to take off for the day. Maybe later we can get into discussing a deeper reason for the skew. But it too is just an offshoot of the basic concept of options as portfolio insurance.

Well of COURSE I'm happy you agreed. My only point is that if one considers skew as a market, different people are buying puts for different purposes, it's impossible to state there is only one reason why they do so. Hence one can't completely explain skew. The way it curves is just based on "no easy free lunch over here" relationships, that's all.

Intuitively it would be hard to accept the fact that an option, a OTM put with a limited final payoff (max(K1-S;0)) would be more expensive than a symmetric one, a OTM call, with a final payoff you can't already know, (max(S-K2;0)).
I mean without implicitly stating that one side is disposed to be much more bloody than the other."The market is a large movie theater with a small door".

 

[atticus]

Symmetry-aside, bounded-risk in short puts is of little comfort when you blow-up.

 

[MasterAtWork]

Quote from atticus:

Symmetry-aside, bounded-risk in short puts is of little comfort when you blow-up.

Please correct me if I'm wrong, you' re "blown up" only if you were leveraged. Since, once again, basically an index can't worth zero. The opposit side, short calls on index can blow you up without leverage. A pretty market increase is enough ( like 2000's).