The only thing I do not like about the argument is that i makes the assumption that when the bad event occurs the deep OTM option seller is wiped out. It is an all or nothing argument. However with good risk management there are ways to hedge during a severe drop to not lose everything. Forgetting a 9/11 situation for a moment, many Market Wizards spoke of how they were heavily long on the trading day before the 1987 October crash and when the market was tanking they liquidated and limited their losses and did not get wiped out. Some even liquidated and went short at the same time for a better hedge and even made money.
If you are short options deep OTM on an index like S&P and the market starts falling, you can short futures (especially for those selling options on futures), roll into butterflies or other similar positions where you lock in a loss much smaller than the max loss. So you take a huge hit but still are alive.
The problem is risk management and a fund putting all of its capital in naked positions so when the shit hits the fan they have no ability to hedge or take defensive positions. If such a fund leverages up the whole account on naked puts then they are truly screwed before the position even goes against them.
Also, the deep OTM option writer is making profits month to month for a year before the bad event hits while the deep OTM purchaser is bleeding. Assume complementary positions where the write makes $250,000 in a year writing on $1MM account and then takes a $200,000 hit locking it in with the right hedging so that it is the maximum loss. The writer after 1 year and one month has an account of $1.05MM after the hit. The buyer, doing the same thing and bleeding $250,000 suddenly hits the jackpot and makes $500,000 (much bigger do to unlimited gain potentials) and now has an account after 1 year an 1 day $1.25MM. Looks good.
But now let's say the bad event does not happen for 3 years. The writer has built up a nice stash of profits which are reinvested and the buyer is wittled down most of the account so that a big hit leaves him in negative territory perhaps. The writer is still positive.
So I can think if many different scenarios where the write does better and where the buyer does better but it has nothing to do with the strategy, but everything to do with the risk management approach.
Fat tails can be non-existent for years bleeding a buyer account such that when it hits big, they are still in an average position, while the seller, if risk management is applied correclty, can survive the bad swing and continue moving forward. On the other hand a buyer may make 3 or 4 times their account on that one lottery ticket. However it is still not all or nothing.
So I do not like the comparison argument that a buyer or seller of fat tails is all or nothing. The buyer could lose very little month to month due to hedges and make a big home run and the seller could make little month to month and hedge the home run. Risk management. Even if the event is unexpected, the reaction to it should not be.
The only exception I can see is a 9/11 event where markets close and re-open already gapped tremendously down with high volume spikes or access to hedging market is limited. Since market techology has improved where the exchanges have stated they would have backups nad not close, I am not sure how it would be handled today. Otherwise this is the true black swan of all swans and the main reason I do spreads instead of naked lol.
If you are short options deep OTM on an index like S&P and the market starts falling, you can short futures (especially for those selling options on futures), roll into butterflies or other similar positions where you lock in a loss much smaller than the max loss. So you take a huge hit but still are alive.
The problem is risk management and a fund putting all of its capital in naked positions so when the shit hits the fan they have no ability to hedge or take defensive positions. If such a fund leverages up the whole account on naked puts then they are truly screwed before the position even goes against them.
Also, the deep OTM option writer is making profits month to month for a year before the bad event hits while the deep OTM purchaser is bleeding. Assume complementary positions where the write makes $250,000 in a year writing on $1MM account and then takes a $200,000 hit locking it in with the right hedging so that it is the maximum loss. The writer after 1 year and one month has an account of $1.05MM after the hit. The buyer, doing the same thing and bleeding $250,000 suddenly hits the jackpot and makes $500,000 (much bigger do to unlimited gain potentials) and now has an account after 1 year an 1 day $1.25MM. Looks good.
But now let's say the bad event does not happen for 3 years. The writer has built up a nice stash of profits which are reinvested and the buyer is wittled down most of the account so that a big hit leaves him in negative territory perhaps. The writer is still positive.
So I can think if many different scenarios where the write does better and where the buyer does better but it has nothing to do with the strategy, but everything to do with the risk management approach.
Fat tails can be non-existent for years bleeding a buyer account such that when it hits big, they are still in an average position, while the seller, if risk management is applied correclty, can survive the bad swing and continue moving forward. On the other hand a buyer may make 3 or 4 times their account on that one lottery ticket. However it is still not all or nothing.
So I do not like the comparison argument that a buyer or seller of fat tails is all or nothing. The buyer could lose very little month to month due to hedges and make a big home run and the seller could make little month to month and hedge the home run. Risk management. Even if the event is unexpected, the reaction to it should not be.
The only exception I can see is a 9/11 event where markets close and re-open already gapped tremendously down with high volume spikes or access to hedging market is limited. Since market techology has improved where the exchanges have stated they would have backups nad not close, I am not sure how it would be handled today. Otherwise this is the true black swan of all swans and the main reason I do spreads instead of naked lol.
