Selling both Puts & Calls - Strategy idea

S

sondermark

I would like to share a strategy idea with you guys and hope to receive some constructive feedback.

Basically I am considering selling both Puts and Calls on the same stock (on the money) simultaneously while maintaining enough cash to buy the stocks long at the strike price. If the stock price rises above the strike price I will buy the stock long; if the price falls I will sell the stock short.

The idea here is to be fully hedged while collecting the option premium on both Puts and Calls. I see the largest risks in large overnight gaps and transactions costs/slippage if the stock price whipsaws.

Comments are greatly appreciated.


Kind regards,
Steffan
 
Not sure what you mean by "on the money", but, basically, you just want to be short straddles/strangles, close your eyes until expiry and hope for the best?
 
Quote from Martinghoul:
Not sure what you mean by "on the money", but, basically, you just want to be short straddles/strangles, close your eyes until expiry and hope for the best?
More...

No, I do not intend it to be a matter of luck. Maybe it is best explained with an example:

Day 1:
AAPL stock: $350.00
Sell May $350 Call: $7
Sell May $350 Put: $7
Pocket $14 and have $350 cash balance reserved for trade.

Day 2:
AAPL stock: $351
Buy AAPL at $351 to hedge Call sold

Option Expire date:
AAPL stock: $360
Deliver stock to call buyer, put expire worthless.
Profit is: $13 ($14 premiums - $1 lost on stock hedge) or 3.7%

Obviously, it is problematic is the price whipsaws the strike price as I will need to buy and sell the stock and thereby increasing costs.


Kind regards,
Steffan
 
The price of an option reflects the anticipated cost of hedging it. Thus there is no merit in your strategy whatsoever, UNLESS you believe that options are systematically overpriced and that indeed turns out to be the case.

If we accept that options are, for the most part, efficiently and fairly valued, then your cost of hedging your short option position will, over time, exceed the premium you collect.

In other words, because you're always crossing bid/ask, you'll lose money.
 
Quote from sondermark:

Obviously, it is problematic is the price whipsaws the strike price as I will need to buy and sell the stock and thereby increasing costs.


Kind regards,
Steffan
More...
Right, so you just want to sell the straddle and delta-hedge it. Why do you think this is likely to be profitable and under what conditions? Let's assume, for now, no transaction costs (meanie's point is spot on, but let's revisit it later).
 
Quote from meanreversion:

The price of an option reflects the anticipated cost of hedging it. Thus there is no merit in your strategy whatsoever, UNLESS you believe that options are systematically overpriced and that indeed turns out to be the case.

If we accept that options are, for the most part, efficiently and fairly valued, then your cost of hedging your short option position will, over time, exceed the premium you collect.

In other words, because you're always crossing bid/ask, you'll lose money.
More...

Thank you for your comments. You are arguing that the price (on average) will whipsaw the strike price and thereby eat up the premium collected – did I understand that correctly?

I am a big fan of back testing, unfortunately I have not been able to backtest the strategy because I miss the historic stick data. While you might be right, I doubt that the premium will be eaten up by hedging costs.

Guess I need to write a small application to it out (paper trading) the next few months.


Kind regards,
Steffan
 
Quote from Martinghoul:

Right, so you just want to sell the straddle and delta-hedge it. Why do you think this is likely to be profitable and under what conditions? Let's assume, for now, no transaction costs (meanie's point is spot on, but let's revisit it later).
More...

In a trending environment (in either direction) the hedge only needs to be bought or sold once before expiration - so in that scenario the strategy will be profitable.

The user “meanreversion” argues that the market have priced in the number of whipsaws (each is obviously a cost) that can be expected. He might be right, but I would really like to see some data on this.


Kind regards,
Steffan
 
Well, rather than putting the burden of proof on me, think about it from another angle..

In order for your strategy to work in the long run, you require that options are systematically overpriced. Why do you think the market would always overprice options, and do you not think that, if this were the case, someone else would have spotted it? Namely, the people who were always buying options and losing money?
 
Quote from meanreversion:

Well, rather than putting the burden of proof on me, think about it from another angle..

In order for your strategy to work in the long run, you require that options are systematically overpriced. Why do you think the market would always overprice options, and do you not think that, if this were the case, someone else would have spotted it? Namely, the people who were always buying options and losing money?
More...

I did not mean to put the burden of proof on you, I would like to test it myself but do not have data for a backtest. Therefore I need to do a slow “forward” test and take all the advice I can get from experienced traders.

For the record: I do believe in efficient markets but there are many reasons for buyers to purchase options e.g. protection. Writing hedged options is basically acting as an insurance company; if there is no “edge” here then the options would effectively be free to the buyer.


Kind regards,
Steffan
 
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