I think you missed the part where he says covered calls, not that selling puts has the same profile as selling calls.
Are naked puts really this safe????
- Thread starter RedDuke
- Start date
To me, the skew is no different than the line on Utah v. Michigan this Saturday, to open the UM seaon. Or pick any other game. The line is not the true odds of winning, it's the estimate of equlibrium for the moneyflows.
This is a misconception. Market makers don't come up with a mathematical theory or a distribution and then stubbornly stick to it, the market be damned. They just make markets based on the public buying and selling, which is what really creates the skew. Market makers are infinitely pliable.
Here's an example of how it works. Let's say it's the first day ever in the S&P500 options pit. The market makers start off with BS prices. There are 50 days remaining and they're using a volatility of 20%. We'll assume an interest rate of 0 for simplicity. Futures are at 1200. Theoretical prices are as follows:
1100 puts - 5.01
1300 calls - 6.58
Throughout this particular day, the futures don't move. Somebody comes in and asks for a market on the 1100 puts. The market makers make a market of 4.90 bid at 5.10. The public buys a few hundred lots at 5.10. A little later someone else asks for a market in the 1100 puts. The market makers have sold all they want to sell at 5.10. So they give a market of 5.10 bid at 5.30. The customer buys a few hundred at 5.30.
Meanwhile, someone asks for a market on the 1300 calls. MM's give a market of 6.50 bid at 6.70. The public sells a few hundred at 6.50. A little later the public asks for a market again. This time MM's give a market of 6.30 bid at 6.50. The public sells a few hundred more at 6.30.
At the end of the day, it looks like this:
1100 puts - 5.30 bid at 5.50, settle at 5.40 - IV is 20.45%
1300 calls - 6.10 bid at 6.30, settle at 6.20, IV is 19.63%
And voila - we have a skew. Purely the result of market forces - greater buying in the put, greater selling in the calls. This much is known, and indisputable.
The next question is - why is there so much more buying in the put than the call?
At this point objective fact ends and theory begins. Nobody can say with absolute certainty why. It seems obvious to me that it results from the fact that the world is long stock, which puts a premium on the put as insurance against a market decline. But that's just my best guess - I can't prove it.
so is there some evil force in selling naked puts that force you to do it with leverage?
Ah, ah, Dmo you are tenacious. Portfolio insurance sounds as a good reason, but if that was the reason, people would try to reduce the cost. Why those people never learned a call purchasing and a short future would be cheaper than the symmetric put? 20 years after?
No we are not.
First we now have a pretty idea on a thread, yours about "being short something". It doesn't mean it's right, but it sounds as if.
The second fact is that you stay on the same way to analyze options with VIX, I can't. That's a pure vol of vol game and it's too short to me to explain the way my positions vary. Please take a look at a volatility surface, you will see that volatility is everything but linear. You may trade only short term options. Nothing wrong with that but you can't generalize this point of view.
I don't think that a 70D synthetic put purchase [30D call + short futures] at 300bp under the symmetric 30D put vol has escaped anyone. IIRC the premium is a lot higher on the 70D, natural or synthetic. Why not buy the 90D synthetic put at 500bp under the 30D put? Perhaps vega sensitivity? Premium outlay?
Maybe I'm dumber than even I've given myself credit, but why are otm puts/itm index calls +skewed, in your opinion?