Selling naked puts option strategy
- Thread starter Twinsen
- Start date
rmorse
Sponsor
By the way, I have clients that sell naked puts, OTM credit spreads etc. They do quite well. They mostly stick to cash settled index options. A few also sell OTM puts in stocks they feel won't go down. They only sell puts they feel don't have a chance of being anywhere close to ITM. Most of these puts are very far away. Many have been doing this for over 10 years.
This is NOT right for everyone. You also need a fair amount of capital to do this and make a living from it. You also need an exit plan for when it goes against you.
This is NOT right for everyone. You also need a fair amount of capital to do this and make a living from it. You also need an exit plan for when it goes against you.
I have also this strategy (enclosed), which employs protective put. But after thinking about it I think it is not good. Because if stock goes up you will have to spend money for buying new long term puts. Not speaking about loss if stock drops and monthly option is assigned but you cannot exercise long term put to cover the loss, because if you do, you lose on long term put time premium.
The problem I always have with this strategy is a completely inverted risk/reward structure that relies on probability of occurrence to prevent the steamroller from showing up.
It's been shown that ATM straddles actually work out better even through extreme 2008 scenarios. Obviously it's more complex than that but if I'm going to take risk I'd rather potential reward be higher than risk and not have to rely on cranking up the juice with a high number of latent-gamma-risk OTM contracts
rmorse
Sponsor
I can't tell you which is more profitable, selling OTM puts in SPX or ATM straddles. I can tell you that selling ATM options requires more skill, attention and analysis. ATM options can and will from time to time be underpriced, while OTM puts are almost "always" overpriced. The big issues with OTM puts is liquidity risk. Under the stress of a large move down in the index, SPX OTM puts often become very wide and illiquid because so many traders are all being forced to hedge all at the same time. It would be very rare for the index to drop that far in a week, but the traders still have to cover to meet margin requirements.
IMO, naked puts selling in cash indexes like SPX works best with the VIX 18-22. You can sell puts for $0.05 and $0.10 that are quite far away. With the VIX below 14, the risks get higher as the OTM puts are closer to the current prices.
BTW, at friday's close, the ATM straddle for next week looks like it's under 10 IVOL while the SPX 1950 puts look like around 27 IVol. Again, this is not right for everyone and you need a clearing broker that will provide the opportunity to sell these. Most don't, which is why they remain so high.
Selling puts, otm or ATM should be compared to owning the stock. As such the proverbial steamroller is the same as you would not leverage a stock position too much.
I guess my point is that if I'm going to get rolled I'd rather it happen on 10 contracts with inherently less gamma risk rather than 150 OTM contracts just waiting to kill me. ATM premium is already providing more leeway for the additional risk of being wrong.
I'm no option expert, but do have some experience winning and losing money with them. Let's take AAPL JUN 130 straddle vs 115/145 (+- 12%) strangle as an example just keeping vol constant for sake of simplicity. Figures are taken from TOS analyzer and maybe a off by a few decimals (current underlying price: 128.77):
130/130 Straddle, 1 contract:
* 670$ of premium
* Initial margin using reg-t: 2585$
* B/E range 1 week before opex: 123.50/136.50
* B/E range 2 weeks after open: 124.90/135.02
* 5 pts beyond where it was sold at (123.77/133.77), 2 weeks after open: -70$/+62$
* 5 pts beyond where it was sold at (123.77/133.77), 4 weeks after open: +25$/+220$
* 10 pts beyond where it was sold at (118.77/138.77), 2 weeks after open: -481$/-262$
* 10 pts beyond where it was sold at (118.77/138.77), 4 weeks after open: -458$/-210$
* 5 pts past strikes, 4 weeks after open: -108$
* 5 pts past strikes, 4 weeks after open w/ +30% IV: -990$
* 20 pts past strikes, 4 weeks after open: -1335$
* 20 pts past strikes, 4 weeks after open w/ +30% IV: -1756$
* Capital needed to hedge with 100% of the underlying at B/E: ~12,350-13,650$
115/145 Strangle, 15 contracts:
* $690 of premium
* Initial margin using reg-t: 19345$
* B/E range 1 week before opex: 118.83/141.05
* B/E range 2 weeks after open: 123.50/136.74
* 5 pts beyond where it was sold at (123.77/133.77), 2 weeks after open: +46$/+394$
* 5 pts beyond where it was sold at (123.77/133.77), 4 weeks after open: +629$/+680$
* 10 pts beyond where it was sold at (118.77/138.77), 2 weeks after open: -1405$/-495$
* 10 pts beyond where it was sold at (118.77/138.77), 4 weeks after open: -9.82$/+454$
* 5 pts past strikes, 4 weeks after open: -450$
* 5 pts past strikes, 4 weeks after open w/ +30% IV: -8700$
* 20 pts past strikes, 4 weeks after open: -9462$
* 20 pts past strikes, 4 weeks after open w/ +30% IV: -18269$
* Capital needed to hedge with 100% of the underlying at B/E: ~178,245-212,550$
This is of course an over-simplification, but selling OTM and juicing up with quantity to meet that same 1 contract ATM premium seems like using a 1 tick PT with a 10 tick stop-loss in outright trading terms. You better be right 95% of the time (which you of course have a higher chance of being "right" with OTM). You can be right less with ATM but also be compensated more for the increased risk. On top of that you can hedge with the underlying a hell of a lot easier than you can with 15x the OTM contracts. You'll probably also suffer less hedging adjustment costs. In my mind, OTM premium selling relies on probability and statistical chance being the only thing saving you from a very bad loss. Additionally, if you want to hedge it constantly you've got to have much more capital to do it with as well.
Robert Morse's points about selling at the right time (taking advantage of volatility) are of course completely valid. One could also sell ATM legs during high volatility as separate legs during defined S/R areas using the increased window as more breathing room for when to put on/take off hedges (they could also do the same thing with OTM straddles). I think it's a given that hedging with the underlying could/would be used in some form or fashion with any of these strategies.
My main issue with OTM strategies are the horrible risk when wrong. Works until it doesn't, then it really turns out badly. This also seems to be the pragmatic results as seen during black swan events. Things like this come to mind:
http://www.surlytrader.com/gamma-hemorrhage/
and
http://www.surlytrader.com/volatility-selling-strategies/
I'm no option expert, but do have some experience winning and losing money with them. Let's take AAPL JUN 130 straddle vs 115/145 (+- 12%) strangle as an example just keeping vol constant for sake of simplicity. Figures are taken from TOS analyzer and maybe a off by a few decimals (current underlying price: 128.77):
130/130 Straddle, 1 contract:
* 670$ of premium
* Initial margin using reg-t: 2585$
* B/E range 1 week before opex: 123.50/136.50
* B/E range 2 weeks after open: 124.90/135.02
* 5 pts beyond where it was sold at (123.77/133.77), 2 weeks after open: -70$/+62$
* 5 pts beyond where it was sold at (123.77/133.77), 4 weeks after open: +25$/+220$
* 10 pts beyond where it was sold at (118.77/138.77), 2 weeks after open: -481$/-262$
* 10 pts beyond where it was sold at (118.77/138.77), 4 weeks after open: -458$/-210$
* 5 pts past strikes, 4 weeks after open: -108$
* 5 pts past strikes, 4 weeks after open w/ +30% IV: -990$
* 20 pts past strikes, 4 weeks after open: -1335$
* 20 pts past strikes, 4 weeks after open w/ +30% IV: -1756$
* Capital needed to hedge with 100% of the underlying at B/E: ~12,350-13,650$
115/145 Strangle, 15 contracts:
* $690 of premium
* Initial margin using reg-t: 19345$
* B/E range 1 week before opex: 118.83/141.05
* B/E range 2 weeks after open: 123.50/136.74
* 5 pts beyond where it was sold at (123.77/133.77), 2 weeks after open: +46$/+394$
* 5 pts beyond where it was sold at (123.77/133.77), 4 weeks after open: +629$/+680$
* 10 pts beyond where it was sold at (118.77/138.77), 2 weeks after open: -1405$/-495$
* 10 pts beyond where it was sold at (118.77/138.77), 4 weeks after open: -9.82$/+454$
* 5 pts past strikes, 4 weeks after open: -450$
* 5 pts past strikes, 4 weeks after open w/ +30% IV: -8700$
* 20 pts past strikes, 4 weeks after open: -9462$
* 20 pts past strikes, 4 weeks after open w/ +30% IV: -18269$
* Capital needed to hedge with 100% of the underlying at B/E: ~178,245-212,550$
This is of course an over-simplification, but selling OTM and juicing up with quantity to meet that same 1 contract ATM premium seems like using a 1 tick PT with a 10 tick stop-loss in outright trading terms. You better be right 95% of the time (which you of course have a higher chance of being "right" with OTM). You can be right less with ATM but also be compensated more for the increased risk. On top of that you can hedge with the underlying a hell of a lot easier than you can with 15x the OTM contracts. You'll probably also suffer less hedging adjustment costs. In my mind, OTM premium selling relies on probability and statistical chance being the only thing saving you from a very bad loss. Additionally, if you want to hedge it constantly you've got to have much more capital to do it with as well.
Robert Morse's points about selling at the right time (taking advantage of volatility) are of course completely valid. One could also sell ATM legs during high volatility as separate legs during defined S/R areas using the increased window as more breathing room for when to put on/take off hedges (they could also do the same thing with OTM straddles). I think it's a given that hedging with the underlying could/would be used in some form or fashion with any of these strategies.
My main issue with OTM strategies are the horrible risk when wrong. Works until it doesn't, then it really turns out badly. This also seems to be the pragmatic results as seen during black swan events. Things like this come to mind:
http://www.surlytrader.com/gamma-hemorrhage/
and
http://www.surlytrader.com/volatility-selling-strategies/
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"This is, of course, the major reason this forum has a lot less value than it should. Instead of recognizing that there are many different ways to trade options, VIX, and many others, assume if you are not doing it MY way you are an idiot. Such an attitude does mark an idiot but the idiot is on the other end of the insult."
Sometimes I can't even believe the #%$@# that people say on this forum. Yes, OBVIOUSLY there are many strategies that work, and far be it for me to say that the ones I have chosen to base my fund on are the best. I'm sure there are dozens of others that are also long-term winners. I've not said anything to the contrary.
But for you guys to try to defend this absolute dud of a strategy just for the sake of argument is laughable. Selling puts 15% OTM puts is a dud for everybody. Not just me, not just you, but for everybody. Why? Simply put, there isn't enough premium in those strikes to cover transaction costs, inflation, and the drawdowns in bad years when it doesn't work smoothly.
Recent example:
TLT on May 12th, IV rank above 90th percentile
- June 102 put @ 0.06$.
- Jan 2016 102 put @ 1.50$
- Jan 2017 105 put @ 6.25$
None of those will yield higher than inflation, and that's at annual IV highs
Ok, some might be saying stocks have higher IV so do them right? Ok, let's assume you had a crystal ball and picked the highest IV day in the past 1 year for the S&P 500. Literally, picked the peak of the peak in vol. LOL, good luck repeating that but let's see...
1 month put @ 12.35$
428 days out leap @ 81$
Again, even if you sold them on the highest IV day of the entire year your annualized returns won't beat inflation.
So you want to go to individual tickers right? You want to ram you thick skull straight through the wall right? Ok, if you're doing individual stocks, we have to factor in DRAWDOWNS when you're wrong. Simply put, forget about it. Even with a crystal ball theres countless strategies with far far better risk / reward profiles. Without a crystal ball, it's a down right joke.
If you stick close to the money, trade 1-3 months out at most, and switch up your underlying to follow the higher IV's, the strategy transforms from a dud into a potential long term winner. I personally use it and it's 13% annualized over 3 years with a Sharpe of 2 and an ulcer of 9.
But anybody, and I mean ANYBODY trading 15% OTM has the math skills of a 6 year old. Stop defending the indefensible. You sound like a rank amateur trader. Some strategies simply don't work at certain strikes. OTM put selling doesn't work that far OTM, period.
Sometimes I can't even believe the #%$@# that people say on this forum. Yes, OBVIOUSLY there are many strategies that work, and far be it for me to say that the ones I have chosen to base my fund on are the best. I'm sure there are dozens of others that are also long-term winners. I've not said anything to the contrary.
But for you guys to try to defend this absolute dud of a strategy just for the sake of argument is laughable. Selling puts 15% OTM puts is a dud for everybody. Not just me, not just you, but for everybody. Why? Simply put, there isn't enough premium in those strikes to cover transaction costs, inflation, and the drawdowns in bad years when it doesn't work smoothly.
Recent example:
TLT on May 12th, IV rank above 90th percentile
- June 102 put @ 0.06$.
- Jan 2016 102 put @ 1.50$
- Jan 2017 105 put @ 6.25$
None of those will yield higher than inflation, and that's at annual IV highs
Ok, some might be saying stocks have higher IV so do them right? Ok, let's assume you had a crystal ball and picked the highest IV day in the past 1 year for the S&P 500. Literally, picked the peak of the peak in vol. LOL, good luck repeating that but let's see...
1 month put @ 12.35$
428 days out leap @ 81$
Again, even if you sold them on the highest IV day of the entire year your annualized returns won't beat inflation.
So you want to go to individual tickers right? You want to ram you thick skull straight through the wall right? Ok, if you're doing individual stocks, we have to factor in DRAWDOWNS when you're wrong. Simply put, forget about it. Even with a crystal ball theres countless strategies with far far better risk / reward profiles. Without a crystal ball, it's a down right joke.
If you stick close to the money, trade 1-3 months out at most, and switch up your underlying to follow the higher IV's, the strategy transforms from a dud into a potential long term winner. I personally use it and it's 13% annualized over 3 years with a Sharpe of 2 and an ulcer of 9.
But anybody, and I mean ANYBODY trading 15% OTM has the math skills of a 6 year old. Stop defending the indefensible. You sound like a rank amateur trader. Some strategies simply don't work at certain strikes. OTM put selling doesn't work that far OTM, period.
I agree with you here. That's why I said in this thread or another that I would view selling naked options as comparable to owning the equivalent stock. In your example the straddle would be 100 shares of risk and the strangle 1500 shares of risk. It's up to you to determine if you want 1500 shares of risk at that reward. Looking at it as notional vs Greeks dampens the impact of an outsized event as all vanilla option strategy risks are maxed at their notional.
In your example the comparable trade is 1 straddle at 670 premium vs 1 strangle at 33 premium but 12percent otm. How much value does that otm have will determine which you trade. you will make less money in the strangle but with a higher degree of certainty.
In your example the comparable trade is 1 straddle at 670 premium vs 1 strangle at 33 premium but 12percent otm. How much value does that otm have will determine which you trade. you will make less money in the strangle but with a higher degree of certainty.
Last post with you.
I don't know why you keep harping on 15percent otm.
1. There was one theoretical example to prove a different point. No one has advocated selling 15percent otm puts systematically.
2. I showed you examples of 15percent otm puts that had significant value in response to your comment that all 15percent options have too little premium to cover transaction costs. You ignored this.
You are making up an argument and refuting it. It's a waste of time to talk to you.
I don't know why you keep harping on 15percent otm.
1. There was one theoretical example to prove a different point. No one has advocated selling 15percent otm puts systematically.
2. I showed you examples of 15percent otm puts that had significant value in response to your comment that all 15percent options have too little premium to cover transaction costs. You ignored this.
You are making up an argument and refuting it. It's a waste of time to talk to you.