How do holds work when selling naked options?

Quote from sirziggy:

To address some. I've been trading almost 20 years. I use a multitude of trading strategies and this happens to be one of them. However, I am simply offering up my .2 on the pro's and con's.

Good. That's the purpose of this forum.

1.. I said, in case of a 20% market move, you aren't going to go broke as many seem to assume.

If the move is to the downside and the puts are naked, then the major loss does NOT come from the 20% move. It comes from the huge spike in implied volatility.

That's the part the poster simply does not get. He thinks that rolling will solve his problem.

2. What do you mean I assume you carry the trade to exp?...

Just based on your saying that sale represented a gain of 10% on each leg. I assumed that meant holding to the end.

If the trade goes against you, you can roll it all the way up to expiration and close the other leg.

The fact that you realize that the other leg must be closed tells me you know what you are talking about and there is no need for any disagreements between us. But, I know that rolling is not always an attractive choice and that sometimes losses must be accepted. I don't see that recognition by the poster.

3. ... Isn't that why most have lost so much in the past 12 months? The pray and hope strategy?

Sure. It's an absurd strategy. But the truth is, they have no idea what alternatives are available to them - except to sell and walk away. Sad.

4. To address this. I'm assuming in a 20% market he just BTC the position and take the 10-15% hit. Obviously, I would have to agree to disagree that on something as liquid as the spy or q's, you couldn't roll you way out, what goes up ALWAYS come down and what goes down, ALWAYS goes up. Aside from bankruptcy or something. But the spy or q's won't go to zero.

It does n't have to go to zero. Or anywhere close. All that has to happen is for there to be a large enough loss to hurt along with an IV spike that kills. If our guy is cash secured on the put side, he would never be forced to liquidate. But there is no such thing as cash-secured on the call side.

The markets may ALWAYS reverse direction in your opinion, but if that comes after your positions are liquidated due to your account moving into deficit, that's not going to be very helpful.

I don't believe they always reverse. It's true they have always done so in the past, but is that enoug to risk bankruptcy?

. I agree on with you on this. If you don't roll or reduce risk or do something, you will be screwed every time.

OK.

7. Please expand on 2008?

Big moves, big IV increase. Option values surged. Naked short option positions bankrupted many.

8. I agree it's good for accumulating stock, but I for one, don't mind buying SPY or QQQ's at a discount. It is what it is.

The writing naked puts on these is an ok method for you.

10. Overconfidence and greed are killers. People lose because they stray from a system or thing they can outplay the big boys. Keep with what you know and don't stray from the original strategy. We all know, you should know your exits before you ever enter a trade. So my advice, know what you're going to do in a bad situation before putting on the trade.

Good advice.
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Mark
 
I have some comments, which I will post in form of questions to stimulate thinking. The first comment relates to cash secured puts. If vol goes up (even if market does not move), then the short put would require more than the cash for the given strike. Therefore, selling a put is never cash secured between the beginning of the trade and its end, even if it is secured at the end.

How do you deal with this problem (assuming you agree and understand my question)? In a brokerage account, your broker can close your short put if for instance underlying does not move, and vol goes to a large number.

The majority of the people may not understand the point above. Short the put is also short volatility. If you have closed out by your brokers, it may happend when bid ask spreads are wide (very wide).

A suggestion I have is to never sell the put, but rather implement it as a covered call. In such case the problem described above does not arise.

If you chose the latter option, then what would you do if underlying reached the strike?
 
Quote from riskfreetrading:

I have some comments, which I will post in form of questions to stimulate thinking. The first comment relates to cash secured puts. If vol goes up (even if market does not move), then the short put would require more than the cash for the given strike. Therefore, selling a put is never cash secured between the beginning of the trade and its end, even if it is secured at the end.

That is not accurate. If you sell one put with a strike price of 40, the put is cash secured if there is $4,000 cash in the account. And you can use the cash you received when selling the option.

'Cash secured' has nothing to do with margin or profits. It only means that there is enough cash in the account to be able to <i>pay for the shares</i> - if assigned an exercise notice.

How do you deal with this problem (assuming you agree and understand my question)? In a brokerage account, your broker can close your short put if for instance underlying does not move, and vol goes to a large number.

The majority of the people may not understand the point above. Short the put is also short volatility. If you have closed out by your brokers, it may happened when bid ask spreads are wide (very wide).

Your broker would issue a margin call (some brokers give you only 10 minutes to comply; some give you zero time) if your margin requirement exceeds your account's ability to meet that call. Yes, If IV surges, the price of the option may result in equity loss and a margin call.

The only way to deal with it is to insure this does not happen. That means never using all your margin, never trading as many options as you can. But if the surge in IV is sudden and you thought you were safe, the only thing you can do is start to shut down positions by yourself - before the broker does it. When they pay the offer (as IB does), they are intentionally hurting you - but they DO NOT CARE.


A suggestion I have is to never sell the put, but rather implement it as a covered call. In such case the problem described above does not arise.

Not correct again. The scenario described above results is a large loss due to the price of the stock. Plus, an IV surge may result in an INCREASE in the price of the call - even with the big stock price decline. If the calls were too cheap, free arbitrage would be available (look up reverse conversions).

Thus, your broker would once again buy you in - this time by paying too much for calls.

If you chose the latter option, then what would you do if underlying reached the strike?

Are you talking about a market rise and an OTM call write? Or an ITM write with a market decline?

If you wrote an OTM CC and the stock rises to the strike, congratulate yourself on a good-looking trade. But, it's too soon to celebrate. There's still plenty of premium in the call and you will probably want to continue to hold.

If you wrote an ITM call and the stock is tanking, your protection is disappearing. What you would do is exactly the same thing you would do if you sold an OTM put (naked) and the stock reached the strike. The situations are identical. Thus, whatever you would do for the latter, do for the former.
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Mark
 
Quote from dagnyt:

Mark
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Mark:

I am not sure you correctly understand what I wrote,or that I am correctly understanding what you wrote, or that at least one of us is wrong although I think that what I wrote is correct and the core of what your wrote is not correct. Some points to clarify:

1. Selling the put or making a covered call (covered with stock) is the same thing (with some exception that we can skip for the moment) if held till the end.

So why are you saying that I am wrong in my what I wrote? It is basic put call parity.

2. To highlight my point on margin, let me give an example (a hypothetical one, but which will explain my point).

Suppose that when one sells a put, the vol is very low, so the put price is close to zero. Let us assume ATM.

Margin requirement at opening is 20% of price, plus proceeds from put (small).

Let us now assume that vol goes to the moon. Put price becomes equal to price of stock.

Margin requirement are now 20% of stock plus differential in price of put which is in total 120% of the ATM strike if stock does not move and vol goes to "infinity"

Conclusion: margin requirment of put can be higher than strike price/stock price (because ATM). Therefore it is technically not cash secured in the sense that between the beginning and the end, one needs more than for margin than what is needed to buy the stock at the end (it is 20% more).

Do you now see my point a bit better?
 
RiskFree,

Personally I consider a "Cash-secured" put to mean that no margin is used. In your example, you mention 20%.

I consider - if an account has $2000 in it, you could sell one put with a 20 strike to be cash secured - that's it. If you sell more then one, or you sell a higher strike put, you are now using margin and are not cash secured.

My brother has an account that is not a margin account and he can sell puts (some people seem to think you can't do this, but you can). If he sells a 10 strike put, his spending power goes down by $1000 minus the premium.

So, since the posibility of the stock going to 0 is already taken into account, then IV has no bearing whatsoever on being allowed to trade this - no matter what IV does, a 10 strike put won't go over $1000.

JJacksET4
 
Quote from JJacksET4:

RiskFree,

Personally I consider a "Cash-secured" put to mean that no margin is used. In your example, you mention 20%.

I consider - if an account has $2000 in it, you could sell one put with a 20 strike to be cash secured - that's it. If you sell more then one, or you sell a higher strike put, you are now using margin and are not cash secured.

My brother has an account that is not a margin account and he can sell puts (some people seem to think you can't do this, but you can). If he sells a 10 strike put, his spending power goes down by $1000 minus the premium.

So, since the posibility of the stock going to 0 is already taken into account, then IV has no bearing whatsoever on being allowed to trade this - no matter what IV does, a 10 strike put won't go over $1000.

JJacksET4
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Your understanding and your example is a main reason why I am warning people. The broker using standard margin calculation would close your brothers's position because if vol rises, margin needed will be more than 2000, even if at the end what will be needed from your brothers money is actually 2000 minus the put premium.

That is why your brother should implement it as a covered call (sell call at the same strike as where to sell put).

I would suggest to your brother to ask for assurance in writing for the eventuality I described. It is not what you consider as cash secured, but what formula computers use to run the business.
 
Quote from riskfreetrading:

Your understanding and your example is a main reason why I am warning people. The broker using standard margin calculation would close your brothers's position because if vol rises, margin needed will be more than 2000, even if at the end what will be needed from your brothers money is actually 2000 minus the put premium.
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Woah! How can a 20 strike put be worth more then $2000? Other then maybe by a $10 spread or something, it's not going to happen! IV can go to 1000 and it won't happen.

JJacksET4
 
Quote from JJacksET4:

Woah! How can a 20 strike put be worth more then $2000? Other then maybe by a $10 spread or something, it's not going to happen! IV can go to 1000 and it won't happen.

JJacksET4
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It is not the worth of the put that is the problem, but the margin computed by the formula which is the problem.

Use the formula for ATM puts, and run it with two values of vol: zero and a large number. You might understand what I mean.
 
Quote from riskfreetrading:

It is not the worth of the put that is the problem, but the margin computed by the formula which is the problem.

Use the formula for ATM puts, and run it with two values of vol: zero and a large number. You might understand what I mean.
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Well, I'm not going to argue anymore, but understand - there is no margin here - my brother doesn't have a margin account. There is no formula - the formula you see is for margin accounts.

They cannot force a non-margin account to use margin. They (the broker) know a 20 put can never be worth more then $2000 and therefore, holding that cash in the account is enough. They cannot force money to be added to a non-margin account.

Let me just say this - On a non-margin account, they cannot and will not require more money be added for a put sale that was done.

JJacksET4
 
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