Credit Put Spread.. ATM vs OTM

[Herkfsu]

It might be 11.10 in your analogy because the otm seller will be selling a higher vol (skew).

As you said it's over simplified because the reality is that that skew isn't free money.

11.10? WHat do you mean?

Any research/articles on the comment that skew isn't free money?

Seems like you are of the opinion is that systematically selling puts ATM vs OTM doesn't change profitability. Is that right? What about favoring one over the other in times of high or low vol? Seem that ATM puts would be more sensitive to change in vol, thus in times of low vol you would want to go OTM and in times of high vol you go ATM.

Makes sense in my head, but I don't know all the details I am sure.

 

[newwurldmn]

11.10? WHat do you mean?

Any research/articles on the comment that skew isn't free money?

Seems like you are of the opinion is that systematically selling puts ATM vs OTM doesn't change profitability. Is that right? What about favoring one over the other in times of high or low vol? Seem that ATM puts would be more sensitive to change in vol, thus in times of low vol you would want to go OTM and in times of high vol you go ATM.

Makes sense in my head, but I don't know all the details I am sure.

There is slightly more edge in selling the OTM puts in your example. This is from the skew (selling otm vol at 18 vs atm vol at 16).

But like you said earlier, that was an overly simplified example. And the existence of skew isn't some weird anomaly. It represents the risk of a severe selloff.

Whether you sell ATM vol or OTM vol depends on your view at the time. Do you think skew is rich or just vol? Maybe you think vol is cheap but skew is rich. It doesn't have to do with high vol or low vol environments necessarily.

There is extra edge in selling OTM (instead of selling 3 vols over realized, you will probably sell 4 vols over) which is really monetizing another risk premium. However, given that you have less vega, it's not always that OTMvega*4 > ATMvega*3.

 

[Herkfsu]

There is slightly more edge in selling the OTM puts in your example. This is from the skew (selling otm vol at 18 vs atm vol at 16).

But like you said earlier, that was an overly simplified example. And the existence of skew isn't some weird anomaly. It represents the risk of a severe selloff.

Whether you sell ATM vol or OTM vol depends on your view at the time. Do you think skew is rich or just vol? Maybe you think vol is cheap but skew is rich. It doesn't have to do with high vol or low vol environments necessarily.

There is extra edge in selling OTM (instead of selling 3 vols over realized, you will probably sell 4 vols over) which is really monetizing another risk premium. However, given that you have less vega, it's not always that OTMvega*4 > ATMvega*3.

Makes sense, I believe the study was 30d atm vol, further OTM the premium should be a bit richer, but vega is lower.

Thanks for the comments!

 

[ironchef]

This is why option sellers overtime beat option buyers. Everyone knows this.

Is this your personal options trading outcome? If so you have my utmost respect and may I ask how profitable are you over time and how much better are you over buy and hold? If not how can you be so sure? I am asking you because my own options trading experience and back tests did not find that to be true for me.

 

[viruscore1]

Assuming the position is held to expiry. Sell put contract(s) atm, the underlying stock must rise above strike price to profit. sell puts otm the underlying stock can rise, stay flat or drop to your strike price (+ .01 in some cases) for the option seller to profit full premium. You're all smart ppl, figure out the odds ...

 

[longthewings]

There is slightly more edge in selling the OTM puts in your example. This is from the skew (selling otm vol at 18 vs atm vol at 16).

But like you said earlier, that was an overly simplified example. And the existence of skew isn't some weird anomaly. It represents the risk of a severe selloff.

Whether you sell ATM vol or OTM vol depends on your view at the time. Do you think skew is rich or just vol? Maybe you think vol is cheap but skew is rich. It doesn't have to do with high vol or low vol environments necessarily.

There is extra edge in selling OTM (instead of selling 3 vols over realized, you will probably sell 4 vols over) which is really monetizing another risk premium. However, given that you have less vega, it's not always that OTMvega*4 > ATMvega*3.

I agree, and your inequality makes the right point....basically, pricing is an absolute necessity. I also like the distinction between risk premia.

To the OP - yes there are plenty of studies showing your premise to be true. If you want to try and make money on it, you need to do a few basic things:

1. Define expected realized vol (maybe in this case, that's ATM IV - 3%).
2. Select your duration (1 month?)
3. Price the whole chain. Price each option using the volatility input = (ATM - 3%). Model price - Market price = Expected P&L for one option at a given strike.

I think it's great that you understand these concepts only apply on average. That said, remember that if you purely sell naked ATM options short, you will never survive in the long-run. You can invoke the Law of Large Numbers / Central Limit Theorem, but only if you trade bounded risk.

One more thing, while your Expected P&L could be positive, if you are not delta hedging then you're also exposed to other risks, i.e. drift. You're not isolating the vol. I'm not saying to try and delta hedge. Delta hedging creates its own host of risks. My point is that your P&L will have a lot of variance. Just be aware of this.

Hope this helps.

 

[Herkfsu]

Is this your personal options trading outcome? If so you have my utmost respect and may I ask how profitable are you over time and how much better are you over buy and hold? If not how can you be so sure? I am asking you because my own options trading experience and back tests did not find that to be true for me.

It is not my personal outcome as I am still learning. The study I posted is where I am getting my rational for the trade. I read mixed reviews of this trade online.

 

[Herkfsu]

I agree, and your inequality makes the right point....basically, pricing is an absolute necessity. I also like the distinction between risk premia.

To the OP - yes there are plenty of studies showing your premise to be true. If you want to try and make money on it, you need to do a few basic things:

1. Define expected realized vol (maybe in this case, that's ATM IV - 3%).
2. Select your duration (1 month?)
3. Price the whole chain. Price each option using the volatility input = (ATM - 3%). Model price - Market price = Expected P&L for one option at a given strike.

I think it's great that you understand these concepts only apply on average. That said, remember that if you purely sell naked ATM options short, you will never survive in the long-run. You can invoke the Law of Large Numbers / Central Limit Theorem, but only if you trade bounded risk.

One more thing, while your Expected P&L could be positive, if you are not delta hedging then you're also exposed to other risks, i.e. drift. You're not isolating the vol. I'm not saying to try and delta hedge. Delta hedging creates its own host of risks. My point is that your P&L will have a lot of variance. Just be aware of this.

Hope this helps.

Thanks.

I was not planing on naked put writing. It would definitely be a spread. Just trying to figure out what width is optimal and at what strike.

 

[ironchef]

Assuming the position is held to expiry. Sell put contract(s) atm, the underlying stock must rise above strike price to profit. sell puts otm the underlying stock can rise, stay flat or drop to your strike price (+ .01 in some cases) for the option seller to profit full premium. You're all smart ppl, figure out the odds ...

I wish it is that simple.

Over a long period, stocks generally appreciate and it is a contest between time premium deterioration vs stocks appreciation. Do you know for sure which wins?

 

[CBC]

The exchange / MM work out the prices based on historical events and their algos. They can't just add an extra 3 points onto IV because otherwise the market will be against the MM when they get placed in a trade as a buyer.


I'm assuming that these 3 points are produced when the VIX is hitting 20-25 or so, you'd have to be the dumbest buyer out there to buy during this period.