Trend following system w/ Option writes

jessie · Jun 14, 2003

I agree, it's something that I only generally do if I don't mind owning the underlying, but otherwise, like covered calls, it's really not something that too many pros do consistently (although I know a few who do) (carefully). It is, however, one more tool in a good option traders toolkit, and can be useful from time to time, given the right situation. If you wouldn't mind owning a stock or leap, but expect the price to be steady or move up or down only slightly in the near term, it can often at least cover all or most of what would be the cost of carry, which for a large position, can be substantial. There are other cases where it makes perfict sense as well, but is only one strategy among many, good for some situations and some traders, but not others. That flexibility is the beauty of option trading, and what separates it from eveything else.
Jessie

spreadem · Jun 15, 2003

I can't conceive of any circumstance where sellings puts is a good strategy,

Selling puts as a strategy can work under the circumstances of a market that has reversed a strong down move, after the option premiums have increased.

The risk lies in the assumption that the downtrend is over, which you really can't know ahead of time.

Trader Pete · Jun 16, 2003

lindq, i think that you make a good point, but selling puts is the same as buying the underlying, nothing more? if you buy 1000 INTC or write 10 INTC puts on the money, you still have the same risk? the only difference is that you don't have to put the money up first (as much) in the case of the short put, and essentially are buying the issue if it pulls back to get execrcised - plus you take a premium in. you might say that there is too much risk to the downside, but the same applies if you outright purchase any other stock or index (you can also set up a "given" stop loss by buying the lower priced puts in a spread).

your quote: "with the single exception of a case where someone actually wanted the stock and was collecting the premium prior to being put the stock" is exactly the reason that people sell puts - to take in premium while you're waiting to buy stock.

lindq · Jun 17, 2003

Quote from Trader Pete:

lindq, i think that you make a good point, but selling puts is the same as buying the underlying, nothing more?

No they are not the same at all. The very BIG difference is that if your underlying rallies and you are holding the stock, you participate in the full move. If you are short the put your only gain is the premium. And I can tell you that few things are more frustrating than watching the underlying take off while your option position gives you only a tiny profit, in return for a great risk. How dumb is that?

On the other hand, if the stock drops, you participate in the FULL loss (or more) with the short put. Yes, you can sometimes repair, but it is a hassle and has its own risks.

And the sense that "it's okay if the stock drops, because I'll just take it in my account", is bullshit and a rationalization. If you sell a put on XYZ and it drops 10% on bad earnings, an SEC investigation, or whatever, are you really going to feel good about being FORCED to take it in your account? Or are you going to feel great about writing more puts for the next six months just to repair your bad trade? Of course not.

It is simply a poor strategy with great risk. Looks great on paper, but sucks in reality.

Trader Pete · Jun 17, 2003

lindq, sounds like you haven't traded short puts well in the past from your quote:

"It is simply a poor strategy with great risk. Looks great on paper, but sucks in reality"

I should have been more clear in my description earlier: when making the decision to "buy a stock" or "sell a put", the idea is the same. Yes, the profit potential is much different, but the two 'positions' are the same.

There are plenty of traders who make a living by selling preimum, so I wouldn't consider the strategy "dumb" as you say...

lindq · Jun 17, 2003

Quote from Trader Pete:

lin
There are plenty of traders who make a living by selling preimum, so I wouldn't consider the strategy "dumb" as you say...

There are certainly people who make money selling premium. But they aren't regularly doing it by selling naked puts, or they will have a very short career.

And I don't agree that going long stock or short the put is the same "idea" at all. It's not the same idea, it's not the same position, it's not the same trade. It's not even in the same universe.

I make this point not to be argumentative, but simply to make damn sure that any new trader reading this thread will know that they are absolutely, positively not the same thing, and that naked puts are filled with great risk and only a tiny reward.

zman7854 · Jun 18, 2003

Quote from lindq:

If you are speaking here of doing uncovered writes, I have three words of advice: Don't. Ever. Never.

In response to your quote, first of all as a trader the words never don't exist in my vocabulary. Appreciate your comments although I think I should be a tad clearer on my explanation. I only write far OTM puts/calls that are extremely overvalued and have a very high probability of expiring worthless.
For example a recent trade of mine was BSX - on the 27th of May Boston Scientific was trading at 50.50, the June42.50 Puts I sold for $1.45 (or $145/contract) the theorectical value at that time was only 7cents, the probability of profit to the seller is 94%, consequently I bought to close the options back at a nickel on the 11th of June for a tidy profit. Also the chart on BSX was looking strong with plenty of support levels below its $50.50 price. When you have all the factors of expensive options, high volatility, time decay and market performance of the underlying on your side it makes it difficult to lose. One drawback about being a writer is that it eats alot of margin in your account. thanks and happy trading.

lindq · Jun 19, 2003

Thanks for the explanation of your trade, and for clearly illustrating my point that in almost every case, a trader who has an expectation that a stock will continue strong will be better off buying the underlying, a future, or even a long option.

On 5/27 when you opened your short put, BSX was 50.50. Yesterday, a few weeks later, BSX closed at 63.10. This was a 25% gain.

So in going short the put, you took on nearly the full risk of owning the stock, and missed out on a huge reward. This is precisely my point.

This is not a theoretical discussion. As one who traded short puts for a long time, I came to see that I was continually cutting short potential profits for the illusion of a regular put income.