Are writing options profitable?

[Jerkstore]

Quote from Eliot Hosewater:

Is 40% Per Month Shorting Index Puts a Fair Return?

http://www.cxoadvisory.com/equity-options/is-40-per-month-shorting-index-puts-a-fair-return/

I hope everyone can see how rediculous this claim is. I was going to go through the study to find the misleading assumptions myself. However the very first post in the discussion section of the article points out the major inaccuracy in the study. The author of this study shows a complete lack of understanding of real world options trading.

"“The paper assumes that a put seller’s capital requirement is equal to the initial cost of the put. However, a put seller has a much larger capital requirement, assuming the seller of the puts plans to continue selling puts after one of the infrequent but very large losses. Specifically, any put seller after October 1987 would know there is a possibility the S&P 500 Index could loose 18% of its value in a month and so must maintain at least 18% of the value of the underlying in cash reserves. Thus, based upon recent prices for puts on S&P Depository Receipts (SPY), the minimum capital requirement of the put seller reduces the 39%/month average profit to about 6%/month.

“An optimistic put seller who wants to continue selling puts after a major market crash might set the required capital reserve at 2x the worst payout or 38% of the underlying, which reduces average monthly return to about 3%. A more conservative put seller might go with 3x the worst payout which implies a monthly return of just under 2%."

 

[houstak]

Quote from Rodney King:

Not surprising they wiped out in '08, but surprising how comparatively little they made in '05- '07.

It is also surprising that they haven't changed anything or closed the fund down after their strategy was proved unreliable (an that is a big euphemism). -68% in 2 months sounds very unreliable to me. Also Jan08 or Feb-Mar07 should have been warnings already.

The low return before is not that surprising in fact when you look how low the premiums were in 2005-06.

This is what I don't like about these mechanical option writing strategies. They might be positive very-long-term-return-wise, but the negative skew will kill you before you can take advantage of that.

I've seen many funds with similarly bad return patterns over 2007-2009, and not only those doing options.

 

[RedEyeFly]

Guys, its not like trend following. If you want your worst month drawdown to be 10% - not 35% then just cut your losses then. Once you're short options you should be more concerned with Vol than price and an indicator as to what is happening in the trading environment. With that you must be able to meter if the losses occurring to your position are those almost permanent delta losses or the more temporary vega losses and if it makes sense at that point to continue to manage and hold out or to cut your losses. For my book, I would not accept a single month loss which is more than one month's expected income, period.

 

[Coolio]

Quote from RedEyeFly:

For my book, I would not accept a single month loss which is more than one month's expected income, period.

I'm going to try to build that into my rules .. that's a concrete way of cutting losses. I haven't had that until now in my credit spread trading activities. The losses have certainly wiped out months of gains.

 

[traderlux]

i have been writing options and have not yet had that big loss that a lot of traders talk about. i have been very conservative in selection of the short strike (otm) and use a long for a hedge. also use mainly etfs to avoid big blind sides that can show up with individual stocks.

i have picked out some of the previous posts in this thread that make sense to me.



Coolio

Registered: Apr 2008
Posts: 88
04-08-10 06:16 PM

Quote from billyjoerob:

What about iron condors? They're your selling options and hoping the underlying doesn't move too much, but you still have protection. I don't understand this strategy at all . . . you're not going to get rich 20c at a time. If you're going to speculate, don't do it halfway.



Its a good strategy if you have low commissions, on penny wide options, tons of open interest and the market is going sideways.

Sideways is the key.

All option stategies must be selected for the right market.

All of my covered call trades have been profitable for the last 6 months: GE, EGO, TSO, GFI because this is perfect covered call weather ... slowly drifting upward/sideways market.

Scale has nothing to do with it: 1 call contract on 100 shares or 10 on 1000., except the sting of comissions is decreased of course on big trading.

Last year, naked put selling was my huge money maker (on volatile stocks I wanted to own anyway.)


christianhgross

Registered: Jul 2008
Posts: 289
04-12-10 04:29 AM

Quote from Metamorphosis:

Check out this CTA. Their main strategy is selling strangles on the S&P:

Be careful with your money when you're selling options.



Since we are pulling up numbers...

I sell options, and I am a contrarian. I use the two to make money since right now on my radar there are only 2 contrarian stocks.

So I did the numbers on option writing, and the reality is that the example you pulled up is an example of how not to do it. I looked at 26 different option trading performance sheets as I wanted to see how bad or good things can get.

The risk to reward is about 7 to 1, but the good guys do about 3.5 to 1. This means if you earn about 5% per month writing options your draw down in the worst case is about 35%. The guys who know how to do this have about a 17.5% drawdown. I am not in the good guys camp, I am more in the 7 to 1 camp.

In this strategy it does not matter how you hedge, or what tricks you do you will get whallopped at one point. You just might not get whallopped at the same time as other option writers.

The fact that the guy lost 50% plus means he is at the bottom of the option writing scale. For him to blow 50% he needs to earn around 7% per month, thus including losses this pushes him to around 9% per month.



RedEyeFly

Registered: Dec 2007
Posts: 170
04-18-10 08:37 AM
Guys, its not like trend following. If you want your worst month drawdown to be 10% - not 35% then just cut your losses then. Once you're short options you should be more concerned with Vol than price and an indicator as to what is happening in the trading environment. With that you must be able to meter if the losses occurring to your position are those almost permanent delta losses or the more temporary vega losses and if it makes sense at that point to continue to manage and hold out or to cut your losses. For my book, I would not accept a single month loss which is more than one month's expected income, period.



Coolio

Registered: Apr 2008
Posts: 90
04-18-10 09:38 AM

Quote from RedEyeFly:

For my book, I would not accept a single month loss which is more than one month's expected income, period.



I'm going to try to build that into my rules .. that's a concrete way of cutting losses. I haven't had that until now in my credit spread trading activities. The losses have certainly wiped out months of gains.

 

[RedEyeFly]

Selling options takes it from a spec game to an insurance game, and at the end of the day your job is to say in business by keeping as much of the premium that you collect as possible.

 

[ambient(MP-5)]

If you take 100$ and earn 40% each month, then you would after 10 years have:

34.305.541.697.309.700.000$

Perhaps thats not really a realistic goal.......

 

[jeb9999]

Quote from ambient(MP-5):

If you take 100$ and earn 40% each month, then you would after 10 years have:

34.305.541.697.309.700.000$

Perhaps thats not really a realistic goal.......

At that risk level you left out the month in which you lose 100% or more.

 

[crgarcia]

Quote from TraderTactics:

I read somewhere that only the Call and Put writers make money, those who trade them are sure to lose more than they gain.

How does that work? It would be nice to know the mechanics of writing calls or puts...

Can anyone here share their views?

Selling OTM options allows a small continuous amount of money...

...until it doesn't, because a cathastrophe happens, and you blowup.
Be sure to limit your losses when you blowup:

Either trading other people money,
or limiting your losses (maybe trading in the name of a company), if you blowup they seize the company assets, but not your assets?

 

[RedEyeFly]

Quote from crgarcia:

Selling OTM options allows a small continuous amount of money...

...until it doesn't, because a cathastrophe happens, and you blowup.
Be sure to limit your losses when you blowup:

Either trading other people money,
or limiting your losses (maybe trading in the name of a company), if you blowup they seize the company assets, but not your assets?

No no, you limit your losses by buying parts of the skew which are less expensive than what you're selling. And then, you stop gate days the market goes nuclear by buying lots of cheap units on both ends (unit = an option with almost all of its premium decayed out of it, its only remaining value at your time of purchase is for a stat. fat tail probability. Units are a bit different on individual issues than on indexes, noted. ) That way you're hedging short deltas with less expensive long deltas and you're covered or even allowed to make a lot of money if you wake up and the company is bankrupt.