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Are naked puts really this safe????
- Thread starter RedDuke
- Start date
Quote from hlpsg:
This seems to be more true of the longer term options than of the nearer term. Why is this?
I've attached an example of the SPX volatility curves of different expiration months.
Even as far out as the MAR09, there is still some evidence of a smile on the upside. This smile is very obvious for months closer than MAR09.
I did the same for RUT, and the smile is evident in the SEP08 and OCT08 options.
For NDX, up to and including the OCT08 expiration, you can see evidence of a smile.
That's an illusion caused by the fact that above a certain point (at every strike above a certain strike), each call is marked at the minimum price. That price is fictitious, because it can't be marked lower than the minimum price. But since the price is fictitious, the resulting IV is fictitious too.
You'll find if you look only at strikes where the call has some "meat" on it - ie the bid is greater than zero - that the otm calls all are at an IV lower than the ATM's. No smile, just a crooked smirk.
This is further explained in a previous post -
http://www.elitetrader.com/vb/showthread.php?s=&postid=2038584#post2038584
dmo--
Your explanation of skew makes total sense to me. Excellent job. I think the reasons for the skew are obvious. The market has dropped 10% or more in less than a week quite a few times, but rises more slowly than it falls. Most people are long stock and worried about crashes so they buy protective puts or put spreads. I trade options on the NDX and part of my position usually includes a few DOTM put spreads to insure against this very disaster. Like Atticus and Charles Cottle, I want to be ready for the steep drop (by being long the wings) whenever it occurs because it will rain money when that happens.
The cost of these puts is simply a relatively cheap insurance policy which totally hedges my portfolio against a 1987 drop.
For others advocating nakedness!--
I can't really see the point of being naked and exposing yourself to the potential disaster all the time. It eats up a LOT of margin, and the market will eventually go nasty on you.
If you want to make money on puts, at least do credit spreads and limit the disaster! Someday, you will be very glad you bought that extra put.
It also seems to me that the initial strategy mentioned in the very first post would work even better with spreads since the maximum loss could theoretically be rolled forward until the market recovered. It could take years, or even decades if you happened to start at a bad time, though. Imagine starting NDX options with this strategy when the NASDAQ was at 5000!! You'd still be waiting, and I'm guessing at least another decade. That's the major drawback of their scheme--decades without return if your timing was poor.
Your explanation of skew makes total sense to me. Excellent job. I think the reasons for the skew are obvious. The market has dropped 10% or more in less than a week quite a few times, but rises more slowly than it falls. Most people are long stock and worried about crashes so they buy protective puts or put spreads. I trade options on the NDX and part of my position usually includes a few DOTM put spreads to insure against this very disaster. Like Atticus and Charles Cottle, I want to be ready for the steep drop (by being long the wings) whenever it occurs because it will rain money when that happens.
The cost of these puts is simply a relatively cheap insurance policy which totally hedges my portfolio against a 1987 drop.
For others advocating nakedness!--
I can't really see the point of being naked and exposing yourself to the potential disaster all the time. It eats up a LOT of margin, and the market will eventually go nasty on you.
If you want to make money on puts, at least do credit spreads and limit the disaster! Someday, you will be very glad you bought that extra put.
It also seems to me that the initial strategy mentioned in the very first post would work even better with spreads since the maximum loss could theoretically be rolled forward until the market recovered. It could take years, or even decades if you happened to start at a bad time, though. Imagine starting NDX options with this strategy when the NASDAQ was at 5000!! You'd still be waiting, and I'm guessing at least another decade. That's the major drawback of their scheme--decades without return if your timing was poor.
Quote from JohnGreen:
dmo--
I think the reasons for the skew are obvious. The market has dropped 10% or more in less than a week quite a few times, but rises more slowly than it falls. Most people are long stock and worried about crashes so they buy protective puts or put spreads. I trade options on the NDX and part of my position usually includes a few DOTM put spreads to insure against this very disaster. Like Atticus and Charles Cottle, I want to be ready for the steep drop (by being long the wings) whenever it occurs because it will rain money when that happens.
The cost of these puts is simply a relatively cheap insurance policy which totally hedges my portfolio against a 1987 drop.
Yes, I think the real and only way to understand the skew is to be in that market with a big position and experience for yourself what it feels like when the S&P jumps 50 points in a day vs what it feels like when the S&P drops 50 points in a day. Once you've had that visceral experience it will no longer be a mystery why people are willing to pay more for OTM puts than OTM calls - for premium at lower strikes vs. premium at higher strikes.
When I was in T-bond options, there were days when the bonds were up 2 points (a very big move), and days when they were down 2 points. The different feel between those two scenarios was night and day. When the bonds were up 2 points, there was no panic. If you were short premium, no problem - there were plenty of calls available to buy at every strike.
But if the bonds were down 2 points - completely different atmosphere. Cold, clammy panic was everywhere. It was unmistakeable - you could feel it in your bones. If you were short premium, you were screwed - no puts were available unless you really paid up. Everybody wanted premium at the lower strikes, which really commanded high prices.
So when I think of reasons for the skew, the first thing that comes to my mind is the wonderful warm relief you felt on those big down days if you were long premium at the lower strikes - like being snug in a cozy bed in an impenetrable bunker as a hurricane raged outside - and how utterly, horribly, unspeakably miserable it felt to be short the lower strikes on big down days. Pain is a huge motivator. If you ask me "why does the skew exist? Why are people willing to pay more for OTM puts than for OTM calls?" My first and most honest and most visceral answer would be "The desire to avoid pain." That's consistent with the concept of portfolio insurance because again, that whole phenomenon stems from the fact that the world is long stock.
Perhaps a more pertinent question would be "is the skew justified ?" In other words do stock index distributions exhibit a kurtosis that the implied skew suggests. From the studies I've done the answer is no, they don't. In fact if you analyse 25 years of data and strip out Oct '87 the Kurtosis is very close to a normal distribution (kurt 3).Quote from dmo:
If you ask me "why does the skew exist? Why are people willing to pay more for OTM puts than for OTM calls?" My first and most honest and most visceral answer would be "The desire to avoid pain." That's consistent with the concept of portfolio insurance because again, that whole phenomenon stems from the fact that the world is long stock.
So the Put buyer is still paying a hefty premium for an event that happened 21 years ago. Justified ?
Quote from Profitaker:
Perhaps a more pertinent question would be "is the skew justified ?" In other words do stock index distributions exhibit a kurtosis that the implied skew suggests. From the studies I've done the answer is no, they don't. In fact if you analyse 25 years of data and strip out Oct '87 the Kurtosis is very close to a normal distribution (kurt 3).
So the Put buyer is still paying a hefty premium for an event that happened 21 years ago. Justified ?
Sell puts neutral with spot and find out. Roll it over.
I've been on and off on ET for a couple of years. But, I've gone back and have read threads a number of years old. The same story repeats itself again and again.
A thread begins with someone saying, "selling naked options are really cool." The experienced traders come back and say "be careful!" The response is, "selling naked options is a consistent money maker, been doing it a couple of years." The experienced traders come back and tell stories of people who made a bunch of money selling naked options and then lost it all in a heart beat. The response is, "I am prepared to adjust." The story comes up again and again and again.
And you know, the real smart, experienced and wealthy traders do make trades on a selected basis that have short negative gamma exposure But, these are guys and girls most of whom who have been or are on the floor and have or do it for a living. They know what the exact risks are and know exactly when to close out or adjust. They are out of most everyone's league posting on this board. They are out of my league.
Mainly I use options to hedge underlying postions. A little piece of my account is to do verticals, butterflies, calanders, etc most all that are 1:1 (buy one sell one) if I am unbalanced its net long like a 2:1 back spread. Sometimes I will be simple leap puts or calls - but not a lot.
The selling of naked options has been asked and answered a bunch of times on ET. I expect the dialogue to continue.
A thread begins with someone saying, "selling naked options are really cool." The experienced traders come back and say "be careful!" The response is, "selling naked options is a consistent money maker, been doing it a couple of years." The experienced traders come back and tell stories of people who made a bunch of money selling naked options and then lost it all in a heart beat. The response is, "I am prepared to adjust." The story comes up again and again and again.
And you know, the real smart, experienced and wealthy traders do make trades on a selected basis that have short negative gamma exposure But, these are guys and girls most of whom who have been or are on the floor and have or do it for a living. They know what the exact risks are and know exactly when to close out or adjust. They are out of most everyone's league posting on this board. They are out of my league.
Mainly I use options to hedge underlying postions. A little piece of my account is to do verticals, butterflies, calanders, etc most all that are 1:1 (buy one sell one) if I am unbalanced its net long like a 2:1 back spread. Sometimes I will be simple leap puts or calls - but not a lot.
The selling of naked options has been asked and answered a bunch of times on ET. I expect the dialogue to continue.