Is there a way to set a stop loss when writing naked options
- Thread starter lasner
- Start date
I've seen variations of this suggestion several times in this and other threads, but it's really situation-dependent and unclear which is "better". It isn't nearly as clear-cut as various commenters claim. The dynamics of multiple verticals (as versus one naked) Greeks-wise are quite similar, and in a situation of poor liquidity, it's preferable to have a single option to trade out of, rather than 8 options (two legs each of four verticals). Do you really want to have to trade an order of magnitude more contracts when liquidity is bad?
If you trade 4 OTM verticals (say, $10 apart, sold for $1 each) rather than 1 naked (sold for $4), your real-life risk (i.e. the risk of losing manyfold on your investment, and/or being margined out) is comparable. Losing 10-fold on your verticals effectively puts you out of business, unless you have near-infinite capital (in which case, the ROI -- inclusive of the "reserve" capital -- is near zero).
Liquidity isn't the primary issue. Risk is.
I agree that it's situation dependent. But with a vertical, you can't get wiped out, or worse. How much that's worth to someone goes a long way toward what's better.
It's a bit of a tortoise versus hare situation. The hare goes for the naked strangles, hoping that multi sigma event doesn't occur. The tortoise is content to grind out more modest profits with a higher probability of success. Most of us here understand the different choices. But to summarize...
The big advantage verticals is that the amount of risk is quantified. If there's a huge expansion of IV (in addition to price gap), the vertical wll not go crazy. The affected naked option will, possibly eating up a ton of more margin (the OP suggested selling strangles). That may hamper subsequent adjustment possibilities. Plus, IMO, the vertcal will have a greater potential for adjustment.
I don't claim right vs. wrong or best vs. worst but I think the double verticals offer more possibilities.
And FWIW, I'd go with a small ratio of more longs to shorts (insurance). I'm a tortoise
There's no such thing - if there was, everybody would be doing it and everybody's account would be increasing. The impossibility of that in a zero sum game should be obvious.
If you're going to trade and make money, you need a real edge - an ability to probabilistically predict future market behavior with enough accuracy to cover your costs. Any trading methodology that doesn't start with such an edge, and then closely follow it with rigorous risk management, is set up for failure.
Writing uncovered OTM options can actually be such a strategy because of the excessive premiums paid for unlimited risk, but the positions need to be TINY relative to your total risk capital (which is not the same thing as your account size). I would size my positions such that a 50% down or 100% up price move for indices (100% and 500% for stocks) across all outstanding naked positions would lose me no more than say 10% of my capital, and one position (or group of highly correlated positions) could lose me no more than 3%. With those guidelines in place I would stick to writing puts (they tend to get an excess of premium whe parity breaks down), and only in high-IV situations where a recovery has already started and the underlying had already moved above the 100EMA. I would only trade limit orders due to the big gaps in options - allways make the other guy eat the gap. So for example being the ask on index puts in April of last year would have been an excellent choice.
That said, you need about $200,000 and about 10 years of experience you don't have before this would be a good idea.
If you're going to trade and make money, you need a real edge - an ability to probabilistically predict future market behavior with enough accuracy to cover your costs. Any trading methodology that doesn't start with such an edge, and then closely follow it with rigorous risk management, is set up for failure.
Writing uncovered OTM options can actually be such a strategy because of the excessive premiums paid for unlimited risk, but the positions need to be TINY relative to your total risk capital (which is not the same thing as your account size). I would size my positions such that a 50% down or 100% up price move for indices (100% and 500% for stocks) across all outstanding naked positions would lose me no more than say 10% of my capital, and one position (or group of highly correlated positions) could lose me no more than 3%. With those guidelines in place I would stick to writing puts (they tend to get an excess of premium whe parity breaks down), and only in high-IV situations where a recovery has already started and the underlying had already moved above the 100EMA. I would only trade limit orders due to the big gaps in options - allways make the other guy eat the gap. So for example being the ask on index puts in April of last year would have been an excellent choice.
That said, you need about $200,000 and about 10 years of experience you don't have before this would be a good idea.
the farther out you go, the less that time decay will help you. Regarding time decay, option buyers want farther out. Option writers want closer to expiration. Time decay is more rapid as you get closer to expiration.