<i>"People do this all the time and make a lot of profits. A few are crushed, but tell me, in what aspect of trading is everyone profitable? Generaly, in all trading, and in life, you will be screwed if you don't manage properly. Not just selling naked put options."</i>
I personally traded this exact-same approach of short SPX options and long ES futures to off-set as needed back in 2002 ~ 2003. Let me hit a few of the high notes for ya, speaking from personal experience. I was playing that game before the current traders OP mentioned ever dreamt of this approach.
The problem doesn't lie in six-sigma events. The real problem comes during extreme sideways volatility. That is the bane of short option players. Those deep out-money puts gain value as the market falls. VIX rises, extrinsic (juice) rises and your shorts take heat.
If you short the SPX 1150 strike in Sep, Oct or whatever back-month contracts chosen, the index does not have to reach 1150 by expiry to cause you pain. It only needs to drop from present 1260s to 1200 and you are in big trouble. Value of those shorts would at least double, possibly triple depending on time left and other factors to keep this simple.
*
Hedging with futures is your next challenge. Once the futures position is opened, your net-loss is locked in IF you either ride both options and futures to expiry OR close out both sides when possible. Decisions to roll out new plays, hold and take the loss or some combination of both are dependent on market action at the time.
While the overnight session exposure exists, there is a slim chance your ES hedge stop-market order will slip dramatically. It is possible for a huge loss to be experienced, but that's true in trading period.
If the people trading this approach have deep pockets and only work shallow portions of their capital, they will be fine. The temptation to leverage up kills most people who play. False sense of security (greed in another form) has them pressing the pedal into next unknown adverse event.
Anyone enjoying +100% annual gains is by that definition grossly overexposed. That approach can be good for +10% to +30% annual with a high degree of success... capital managed properly. I can tell you for an absolute certainty that 100% annual gains = too much exposure on contracts for disaster OR string of choppy losses.
It would take a modest pdf book to explain all parameters involved here. I know, because I wrote one in 2002 and marketed it. A few traders who bought the program = concept have gone on to make solid but modest gains every year. It requires every bit of patience, discipline and fascist money management as any option-spread strategy does. In essence it is merely legging into cross-market credit spreads as price moves against you.
atticus has forgotten more than most people in ET will ever know about this subject. I also know the parameters inside-out myself. Trust us when we tell you that 100% annual gains will end in Neiderhoffer results, 100% certainty. Gearing it towards 10% to 30% annual gains with sufficient capital is another story.
