Premium Sellers vs. Option Buyers

[Squilly_D]

Quote from Maverick74:

As a disclaimer I'll say for the record, there is no wrong or right way to trade. And every trader has to line up their personality with their strategy. Having said that, having traded for several prop firms, having been around 1000's of traders in my life, having studied 100's of some of the greatest traders that ever walked the earth, my conclusion is, you are more likely then not to not be successful if your strategy seeks out small winners. And no I'm not including HFT traders, flow traders, algo traders etc that make 1000's of trades a day eeking out small winners. I'm talking about joe sixpack. I think the only way you stand a chance is to make sizeable gains. In other words, you're going to have to get lucky every now and then. Without big winners, if you are selling premium and collecting pocket change, over time you are likely not going to outperform a broad based index on a risk adjusted basis.

Let me also point out before anyone gets too excited and tells me how much they made the last 4 years, the p&l symmetry of a premium seller is highly correlated to a broad based index. In other words, the market has gone up for 4 years straight and vol has gone down for 4 years straight. You SHOULD be making money in this environment. But don't kid yourself, your basically just long an index. The second this trend changes, you're going to start learning a lot about yourself. [/B]

Maverick,
Interesting comment and I value people’s opinion. I currently don’t sell naked premium in the indices do to the low vol, but there are plenty of strategies for low vol also (debit verticals, calendars, diagonals, etc.) So I truly believe that one needs to keep cognizant of the market, or have a keen market awareness and not just doing stuff willy nilly.

Even in this low vol environment though, there are still some nice high vol trades occurring in individual stocks (I stick to the most liquid ones at that). I’ve come to appreciate earnings plays for that (higher vol prior to the day of the announcement, vol contraction after). This has also been true in different commodities and currencies in the last few months (gold through the use of GLD and the Japanese Yen through the use of FXY). They both had 100% IVP (Implied Vol Percentile, or their highest Vol in the last 52 weeks). I utilized the hell out of some credit spreads and IC’s during that time.

Finally, as a retail investor, I’m personally trying to mimic the different institutions that have large number of trades occurring at once…It increases my chances of being right! I manage my winners when I have them, stay small in ALL positions (no one position can destroy me). I average anywhere from 25 – 35 positions going at once (some in the same underlying). Long story short, I emphasize strategy over direction, staying relatively small in positions vs. overall capital, and trade a HELL-OF-A LOT!

 

[Squilly_D]

Quote from Brighton:

Squilly,

You must have caught Maverick on a good night. Some time in the last couple of weeks he called premium selling as a primary activity "for the brain-dead and the lazy" and probably a few more pejoratives.



That said, I'd recommend re-reading his message carefully. He's right that this subject has been hotly debated and it's worth your time to check out some of the old discussions. Tip: You can sort all posts in a forum by activity - some of the "options selling" posts have a very high count so they're easy to find. He and Comintel are also right that you haven't been doing this for very long and you've been doing it in a very tranquil environment.

My advice: Use leverage responsibly and make sure you're stress-testing your portfolio for price and volatility shocks. Some of the "limited risk" spreads you have can put you in a world of hurt if volatility explodes.

Brighton,
Point taken. Well then, I guess its good to know that I'm learning from someone with over 30+ years of trading experience, Tom Sosnoff!

 

[Squilly_D]

Quote from Brighton:

Squilly,

My advice: Use leverage responsibly and make sure you're stress-testing your portfolio for price and volatility shocks. Some of the "limited risk" spreads you have can put you in a world of hurt if volatility explodes.

Brighton,
By definition, a spread can't win or lose more than defined at trade entry (at least conventional spreads like verticals, IC's, butterflies, calendars, diags, etc.) I would believe in that case, the risk is limited. Even if one (some) of the options get exercised, the risk profile doesn't change, only the required capital. If I don't have the amount in the account after exercised options, I close that entire position (this has happened a few times). In the end, if I was up/down on that trade, I will be up/down after options are exercised on my position, at which point given the next available opportunity to do so, I close the position to free up the capital.

 

[Squilly_D]

Quote from Dael:

How far in SD's you choose strikes when going in? I usually keep them between 1.5 and 2 SD's, thinging it's a good balance of premium and success probability.

I did an earnings play on NFLX the day of their earnings announcement (they announced after market close) and their IVP (Implied Vol %) was I believe greater than 80% at the time. I don't have the #'s anymore (spreadsheet), but I recall that I was able to get about ~3.2SD (just sold 2 calls) out of the money, which was amazing because it was the current weekly options at the time. If I can't do that, then I consider different strategies. I’m still learning though and that was how I approached it.

 

[comintel]

Quote from Dael:


Increased vol means increased premium means you can widen your strikes far away, doesn't it? [/B]

If it steadily increases it will (on average) cause you steady losses for as long as it keeps increasing.

 

[Dael]

Quote from comintel:
If it steadily increases it will (on average) cause you steady losses for as long as it keeps increasing.

True. Nevertheless, raised vol and so unrealized loss doesn't hurt me until I'll figure out chance are high to be expired in money i.e. price is close to strikes. That's why I prefer to be exposed for as short as possible, shorting month expiration options.

 

[Squilly_D]

Quote from comintel:

If it steadily increases it will (on average) cause you steady losses for as long as it keeps increasing.

Not necessarily. There are strategies for increasing vol. If vol is low relative to where it has been for a particular underlying, then use those types of strategies regardless of direction/range one is betting. This does not mean you will win the bet/trade, but a least a possible vol expansion won’t be the reason why you had to stay in a trade longer in order to see if you would win (be able to manager a winner/make a profit) prior to the options expiring.

 

[comintel]

Quote from Squilly_D:

Not necessarily.

Yes necessarily on average on an overall short position, which is what I was discussing.

This is just obvious - if you are selling volatility, you need it to go down, not up.

There are strategies for increasing vol.

Only not being excessively short premium or legs or volatility.

You never know ahead of time when the market will switch to a regime of rising volatility.

If vol is low relative to where it has been for a particular underlying, then use those types of strategies regardless of direction/range one is betting.

Volatility does need need to be low to go much higher. It might be already high and end up much higher still (e.g a rolling market crash).

I am talking about risk scenarios, not about the most common case.

I am just pointing out that you can have long runs of losses, even on limited-risk positions. This should not be hard to agree with.

You can definitely make money selling options with very good risk control though.

This does not mean you will win the bet/trade, but a least a possible vol expansion won’t be the reason why you had to stay in a trade longer in order to see if you would win (be able to manager a winner/make a profit) prior to the options expiring.

 

[RedDuke]

Hi Maverick,

If one sells ES naked calls/puts for example, what would be the best hedge in your opinion? I know a futures contract can help, if ratio is set correctly. Anything else?

Thanks,
redduke

 

[RichardRimes]

Quote from Squilly_D:

I guess that depends on trade strategy I'm anxious to be part of an increasing Vol environment as a premium seller. I believe it will allow me get FURTHER out of the money (3 - 4 standard deviations away from the ATM) and collect premium (for those types of strategies of course).

I primarily sell premium (and listen often to Tom and Tony in the early am) but do buy it in low vol environments. I would caution you on the idea of going too far OTM in high vol simply because it is so easy to become complacent and there is a higher risk/reward involved. Also what IS high vol?? That gets pretty subjective...the average the past year? 5 yrs? 10 Yrs? However since you ARE trading small the lessons you learn will not cost much. Good luck...sounds like your on the right track.