selling index calls anticipating a reversal

[Kicking]

What are the pros vs cons of selling naked calls instead of buying puts when looking for an intermediate top. Obviously the reward is better with puts but when selling premium you put time on your side which is a tremendous advantage when playing the downside since perfect timing on the short side is so difficult . Vol is low as it's ever been pretty much but if you are right on direction, you will make money at or close to expiration .

and what about European style calls options, do they sometime sell at a discount ? shoudl you then refrain from selling them ? how do you see if they are fair valued when they are out of the money if there is no US style equivalent?

 

[riskarb]

You earn a bit from vol-skew if selling ATM into a bear-reversal, but a rise in strip vols will attenuate any skew gains. Call it a wash -- in any case, it's not an inferior strategy based on vol or smile, unless we have a true crash scenario in which vols on deep otm calls can rapidly expand into a broadening distro and increased demand for synthetic puts.

Don't concern yourself with euro put discounts to intrinsic, but it's accounted for in the models. On paper, it may look like euro puts are trading at a nice discount, but there is no free lunch. The discount is a function of the forward, not the spot price. American calls will look to trade a little richer under BS, but no concern. There are no advantages to amer/euro conventions.

 

[thenewguy]

I'm sorry, but what is "strip vol"?

Thanks,

- The New Guy

 

[riskarb]

Vols taken vertically, across strikes. What the VIX represents.

 

[thenewguy]

How is that different from the vol smile/skew, or is it just another term for it?

Thanks,

- The New Guy

 

[riskarb]

Skew denotes the convexity[curvature] of the smile.

 

[thenewguy]

and strip is an average/mean of the front month strikes?

*sigh* I can't wait til I can speak to people intelligently about these topics.....

- The New Guy

PS. Hey, while I've sort of got you cornered...

I've always wondered about how vol affects the premium of ITM/OTM options. Intuitively, it seems it should have an inverse relationship, meaning that rising vol should increase the premium of OTM's and decrease ITM's premium and vice versa. Often, however, I read that "in general, as vol rises, premiums rise too." Am I out to lunch with my thinking?

 

[riskarb]

Quote from thenewguy:

and strip is an average/mean of the front month strikes?

of vols, yes

PS. Hey, while I've sort of got you cornered...

I've always wondered about how vol affects the premium of ITM/OTM options. Intuitively, it seems it should have an inverse relationship, meaning that rising vol should increase the premium of OTM's and decrease ITM's premium and vice versa. Often, however, I read that "in general, as vol rises, premiums rise too." Am I out to lunch with my thinking?

No, they don't change modality[invert] but the OTMs can carry +convexity, increasing the slope[skew] of OTM vols. It's an asymmetric-distribution; the OTM puts and ITM calls gain the most from +convexity, but OTM calls and ITM puts can gain vols as well, but the OTM calls and ITM puts lose curvature

 

[Profitaker]

Quote from riskarb:

On paper, it may look like euro puts are trading at a nice discount, but there is no free lunch. The discount is a function of the forward, not the spot price.

I thought the discount was a function of the value of early exercise.

And if you can find an instrument with both Amercian & European style options available, you can pocket the early exercise value and take a risk purely on early exercise.

For example, short Amercian style xx strike Put, long European style same strike Put. Done for a credit and known as an Atlantic spread. No intrinsic loss possible, only assignemnt risks.

Anyone traded it ?

 

[riskarb]

Quote from Profitaker:

I thought the discount was a function of the value of early exercise.

And if you can find an instrument with both Amercian & European style options available, you can pocket the early exercise value and take a risk purely on early exercise.

For example, short Amercian style xx strike Put, long European style same strike Put. Done for a credit and known as an Atlantic spread. No intrinsic loss possible, only assignemnt risks.

Anyone traded it ?

I wasn't making the argument relative to american options; simply the apparent discount arbitrage which doesn't exist, but you're correct.

Sure have, but not in years.