Right.I would like to add that there is a widespread misconception that selling premium entails some kind of wild risk that only a fool would undertake. I have made the case that selling puts is less risky than an equivalent stock position - it's just simple math really. The important thing is that I have the position cash-covered, I'm not leveraging with margin.
I've been selling premium for about 3 years, and I have a data sample of a couple of thousand trades. My returns so far are between 25% and 35%, but I think I can improve going forward, since I have learned a few lessons and abandoned a few strategies that were not profitable.
The conventional wisdom seems to be that premium sellers are collecting pennies in front of a steamroller, unwittingly setting themselves up for the inevitable catastrophic loss that will wipe them out. Rolling is usually dismissed as loss avoidance, but I have never seen anyone discuss the approach that I use.
First, I sell weekly puts that are cash-covered. I never use leverage. I trade volatile stocks with high IV, so that I can collect between 1% and 3% per week. I typically sell fairly close to the money, often the next lowest strike, so many of my options move into the money. How do I deal with this?
The key is that the options I trade must have enough premium so that I can roll down and out (usually one strike for one extra week) for a credit. If I can collect 10 to 30 cents additional premium, I can still have a substantial return when I'm finally low enough for the option to expire.
If the put moves far enough into the money, I won't be able to roll with a credit. But in most cases, the debit is small enough to preserve most of the original premium collected. If the stock keeps moving down, I can do this for weeks, until I am back underneath it.
Occasionally this strategy can result in being very far in the money. I have carried options that are 10 or 11 points in the money. In situations like that, it may not be possible to close the entire trade with a profit. But we all know that losses are a part of trading, right?
The probabilities of being in a trade that goes against you that much are low. I am also susceptible to a black swan event. But I have much more flexibility with options than I would with a simple stock position, where I am locked into an absolute price point. With options, I can make adjustments, trading time value for intrinsic value all the way down, so that my loss will be half that or less of a simple stock position.
Just interested to see if anyone else trades this way or has any comments.
Not quite, he already owns the stock if he sells puts without leverage.your strategy should be fine until a stock makes beyond a two standard deviation move. At that point you will become an investor holding a stock with big losses
Thank you for elaboration. Don't you consider adding a far OTM cheap long put leg to your plays to hedge from black swan events or it's not worth it?If the put still has time value, I'll keep it until it erodes. Then I would roll it down as far as needed to pick up more time value. This scenario would likely result in a loss. But you still have options, you could take assignment if you liked the stock and write calls.
My strategy doesn't prevent losses, especially for catastrophic or black swan events such as you hypothesize. But it does mitigate the damage. If you are diversifying, you will make enough on the other positions to not suffer too much from the occasional large loss.
Smallfil, I doff my hat to you if you are able to buy options and make money. I could never do that and it would make me a nervous wreck.
I sold WLL 31 puts today when the stock was at 32.01 for a premium of 67 cents. The stock is now at 30.82. As things stand now, I could go down to a 30 strike for the following week at even credit.
Not quite, he already owns the stock if he sells puts without leverage.
That is equvalent to covered call writing (stock long + call short, put call parity).
Compared to buy and hold, selling puts is less risky in bear markets (because of the additional premium from the call).
The offset is that it is less profitable in bull markets.
So I wonder more about his 30% yearly last 3 years. Must have been very high IV stocks (meaning they dipped before he sells puts?).
When you sell a put you take on the obligation to buy stock at the strike price. You don’t actually own it till it is assigned. Leverage has nothing to do with that but it can amplify the potential losses. The end result is that you start to inventory stock with losses. Which you want to square up with wins at the end of year. Hopefully you have more wins than losses.Not quite, he already owns the stock if he sells puts without leverage.
That is equvalent to covered call writing (stock long + call short, put call parity).
Compared to buy and hold, selling puts is less risky in bear markets (because of the additional premium from the call).
The offset is that it is less profitable in bull markets.
So I wonder more about his 30% yearly last 3 years. Must have been very high IV stocks (meaning they dipped before he sells puts?).
That is not what I said.You don’t actually own it till it is assigned.
That is not what I said.
Again, selling puts is equivalent to covered call writing. That is "put call parity" the most basic option pricing principle, it is in every option book.
If he sells a put, he can think of it as a virtual stock long and a virtual call short (it is the same in the absence of dividends or generally cost of carry).
if you have a Move like that there is not much you can do. Buy the put back for a loss or assume the stock and sell covered calls but most likely at that point a move like that is so destructive and final that you are best moving on and taking the loss. If you have diversified and managed position size well, it will be just a minor hick up or speed bump on the road. Rolling down and out puts won’t cover the loss in this example.