What is the optimal portfolio allocation (%) to naked options?

[tonyf]

ZERO, ZERO, ZERO

Your problem is in your point 1, "you may have to sell other assets" . By holding them now you do not want to sell them. Why sell them by force latter ???

Chances are:

The whole market crashes, you get your new assigned goods by selling discounted holdings you may not want to sell at the level they are now at.

Or the market is rallying and your put tanks because of some fumble by the underlying company, and you get to sell "good" holdings out of the rally to put good money in a stock you know "may not want to own".

These ideas look good on paper but never seem to work out when it hits the fan.

All this is relqtively easy to stress test.

You own 1m of MSFT shares.
Write naked puts with face value of 900,000.
Liquidate your MSFT shares drop 10 percent.

 

[xandman]

$35 stock x 100 shares =$3500 x .50 delta = $1750 delta dollars

IBKR has that data column, if you include it in your portfolio display.

 

[tonyf]

Thinking about all this: what if you think that your portfolio will loose 20 percent in a meltdown. Would it not be easier to write puts where if exercised, they do not require more than 80 percent of your portfolio's NAV?

 

[xandman]

Absolutely, not.

Put writing strategies are the worst performers. Moreover, how do you think you will hold psychologically seeing your portfolio doing worse than the benchmark at the worst of times? You will choke and liquidate. Everybody does.

Cash set aside for a put is not the same as cash set aside.

 

[tonyf]

Absolutely, not.

Put writing strategies are the worst performers. Moreover, how do you think you will hold psychologically seeing your portfolio doing worse than the benchmark at the worst of times? You will choke and liquidate. Everybody does.

Cash set aside for a put is not the same as cash set aside.

Not being thick, but I have no clue what you are taliing about?
Investing is establishing a strategy and following it. Why all the drama?

 

[tonyf]

Not being thick, but I have no clue what you are taliing about?
Investing is establishing a strategy and following it. Why all the drama?

As long as the premium collected exceed the cost of funding, I am in the money.

 

[xandman]

As long as the premium collected exceed the cost of funding, I am in the money.

You might be one of the rare ones who really buys and holds thru bear markets. Not for me to dissuade what works for you. The idea has merit.

But, let us look at the trade very simply and in isolation:

How much is the premium as a percentage of the contract's face value? What happens when the face value of the contract is worth 20% less?

 

[tonyf]

You might be one of the rare ones who really buys and holds thru bear markets. Not for me to dissuade what works for you. The idea has merit.

But, let us look at the trade very simply and in isolation:

How much is the premium as a percentage of the contract's face value? What happens when the face value of the contract is worth 20% less?

So here is an example:

1) You own 1000 shares of google @$1,500 (long shares) = $1.5M paid.
2) You write 10 60-day $1,800 OTM calls for a premium of say 2%. Your borrow rate with IB is 1.5% per year, so will eat 0.25%*maintenance margin (let's call that peanuts for now).
3) You sell 10 60-day $1,200 naked puts for another premium of 2%.

Now price drop to $1,300: you sell your google shares for 1.2M book a loss of 20% and are assigned (forced to buy 1,000 shares from counterparty). So zero sum game excluding commissions and premium recieved.

Price Jumps to 1,800: you give your shares to the call counterparty and book a 20% profit + premium.

What is wrong with that logic?

Applied to a portfolio (less liquid): I could sell puts at 80% of NAV instead of 100% to provision for slippage.

 

[xandman]

It assumes a lot. For the previous example, we have 20% loss on Google shares which is about $300,000 face value.

The 63 day 1500 strike put is $95. You sell 10 puts ATM and book $95000. So, we would expect a net loss of 205,000 if held to maturity.

The issue is the timing of the loss. If it happens on 50 days to expiration, you will find that those options already have a value of around $300,000. You will be thinking hard whether to buy it back. Realize the loss immediately or hope for a bounce that may never come.

If your doing it as cash secured, it's just another trade. But if you are using puts to free up cash and do more trades, you are employing leverage. Not exactly bad, but your returns will be significantly worse in a bear market.

80% of NAV seems conservative. Be careful with the rosy return calculations doing 60 day put sales to eternity. 1 month out of 12, you will give it all back. The Theta erosion probably does not amount to additional returns. You could get an additional 200-500 bps (my guess) from the volatility premium.

 

[tonyf]

It assumes a lot. For the previous example, we have 20% loss on Google shares which is about $300,000 face value.

The 63 day 1500 strike put is $95. You sell 10 puts ATM and book $95000. So, we would expect a net loss of 205,000 if held to maturity.

The issue is the timing of the loss. If it happens on 50 days to expiration, you will find that those options already have a value of around $300,000. You will be thinking hard whether to buy it back. Realize the loss immediately or hope for a bounce that may never come.

If your doing it as cash secured, it's just another trade. But if you are using puts to free up cash and do more trades, you are employing leverage. Not exactly bad, but your returns will be significantly worse in a bear market.

How so? It's zero sum game: you own the GOOG shares in any case.

You sell at $1,200 to satisfy options assignment obligations (becoming a CSP effectively) and sit tight. If assigned,you are long again the same amount that you were long in the first place.