I agree for the most part, but I think one of the main reasons that people lean toward selling on the call side is that the underlying is more likely to crash than to rally hard. Upward moves are generally slower and allow for more opportunities to adjust. So although the premiums might be larger on the puts, it would seem that the position is more risky.
Covered call is more risky than it appears?
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I agree for the most part, but I think one of the main reasons that people lean toward selling on the call side is that the underlying is more likely to crash than to rally hard. Upward moves are generally slower and allow for more opportunities to adjust. So although the premiums might be larger on the puts, it would seem that the position is more risky.
This is the general position taken usually against my type of trading. It involves static analysis of same lot size unfortunately and doesn't incorporate the dynamic analysis of varying how much you increase your position size etc. All of that is directly correlated to how the market is. You don't bet the farm ever, but especially not on the first leg of a move against you. The last loss that I took in options was Sept 1992 Soybeans. A guy talked me into doing a vertical bull call spread (essentially a covered call). That was the last position that lost any money.
It depends on how you define "edge", I suppose. I could sell a RMBS 65 call today for .20. I believe I have a 99.999% chance of it expiring worthless in two days. I'd call a >99% chance an edge. The purchaser disagrees, obviously.
Options are all about transfer of risk, price action is secondary. If you're buying my 65C, you're transfering the risk of the stock shooting above 65 to me. At the moment, I'm happy to sell it to you because I believe the odds of that happening is far lower then you do. I'm trading odds, not price action.
But then, I'm just one trader, others look for other things.
Another misconception thrown about on this thread: Options are one shots. You buy or sell one, and it either expires in the money or not. Again, options are about transfer of risk. If I'm short premium, I'm managing my overall delta carefully. If gamma becomes severe, I'll lose very quickly, which is why I'm constantly making adjustments.
Take GOOG. I sold a 440, 240 strangle on 3/20. My delta was zero. After the "pop" to 360, I became very delta negative. I could do any of:
1) Buy back my 240 put and sell a 260 put.
2) Buy some stock (~10 shares)
3) Buy some 460 calls
4) Sell more 240 puts
5) Sell my 440 calls at a loss
Any of those three actions would get my delta back to somewhere near 0. So, on 3/24, am I:
1) Bullish? If so, I'd sell several 240 puts or even a few 260 puts.
2) Neutral? If so, I'd buy back my 240 put and sell a 260 put.
3) Very bearish? Do nothing.
4) Slightly bearish? I'd buy back my 240 put and sell a 250 put.
5) Want to get in deeper? I'd sell more puts and calls (2 to 1 ratio)
6) Want to back out? I'd buy back my winning puts and maybe buy a few shares of stock.
Over the last 5 weeks, I've made at least 10 adjustments to this position. I never took a single loss on any leg.
If GOOG hadn't decided to announce earnings tomorrow, I would have kept the position to expiration and won pretty significantly. As I'm more risk averse then that, I closed out my remaining legs (some for a loss, but overall for a gain).
At any given point, my combination of options and stock would allow for a 10% price movement while only losing about $200. I made between $150 and $250/day in theta.
I made much less money then if I had just bought 400 calls, for example. But, I made money each day, I didn't take on huge amounts of risk, and was able to adjust in a multitude of ways to keep the position within my risk parameters.
This isn't Martingale, it's simply managing risk parameters. Adding to a losing position is normal both in stock and options, but particularly so in short premium situations.
A lot of useful information in your post and quite a bit of time was invested in it's contents. Thank you. I would say we differ in one aspect at least with short premium and that is with the delta. This by the way is the only greek that I have an idea of it's meaning. Where we differ is I don't pay attention to the delta, rather , I just keep the overall position size small enough as to never get hurt too bad. When I add premium at farther strikes and increasing size, I'm sure it throws the delta way out of whack, but those sales make up for closer strikes perhaps going in the money. The position never gets out of hand, because I don't start out greedy.
It isn't about static analysis. When you sell OTM and the underlying moves against you, then you must buy back the position at a loss. You then sell a larger quantity further OTM with the same expiry. The premium recieved from this new position was determined not by the previous static valuation, but by the current probability that the short strike will be breached again by expiration.
In this strategy you are simply accepting the loss from the first position along with greater risk on the second position, that will allow for a profit big enough to offset the original loss. After every adjustment the R/R is less favorable. In this sense the strategy banks on the idea that your bank roll never runs out. I admitted that this strategy prevents short term loss, but anyone who recommends this to a small account novice is irresponsible at best. The initial position would have to be so small that commissions would completely wipe out any potential profits.