It's like free money until the fat tail hits...
"Eat like a mouse, sh!t like an elephant."
"Eat like a mouse, sh!t like an elephant."
Writing naked calls in a down market
- Thread starter doragio
- Start date
Thanks everyone for the views and replies. I don't mean to simplying trading options given that I haven't traded them. So bear with me here when I try to relate general trading to options.
Back to that writing naked calls example, if the underlying equity does turn against you and shoot up, couldn't you cut it by buying back the option at a loss? With that in mind, wouldn't it not wipe you out totally if you just integrate the risk control like with any other style of trading?
It seems like this would be the same case with shorting a stock and covering if it goes wrong against you. Now you got the leverage with options, but with the chances of you being right more than wrong and being able to cut losses; it seems like the risk and reward balance out.
And with respect towards a downard market, in an upward market, wouldn't you be able to do to the reverse? Maybe I'm missing something here, so appreciate you guys helping me make sense of this. And I'm not trying to simplify what you guys took years to learn and do, but just would like to get a handle on this.
Best,
Back to that writing naked calls example, if the underlying equity does turn against you and shoot up, couldn't you cut it by buying back the option at a loss? With that in mind, wouldn't it not wipe you out totally if you just integrate the risk control like with any other style of trading?
It seems like this would be the same case with shorting a stock and covering if it goes wrong against you. Now you got the leverage with options, but with the chances of you being right more than wrong and being able to cut losses; it seems like the risk and reward balance out.
And with respect towards a downard market, in an upward market, wouldn't you be able to do to the reverse? Maybe I'm missing something here, so appreciate you guys helping me make sense of this. And I'm not trying to simplify what you guys took years to learn and do, but just would like to get a handle on this.
Best,
Gaps are what will eventually kill you. So risk management, as you have correctly noted, is the single most important issue, which means discipline in following your strategy and not overleveraging!
Sure you can, but the key is identifying the changes in trend and even then the markets don't move in a straight line. You can make money for months and then get wiped out on a move a la Bear Stearns. There's no free lunch in the market.
The options market are priced in such a way that call/put writers and call/put buyers really will not have an advantage. You cannot profit by putting on a blindfold and doing any of these.
You only make money by having an edge, an angle on near/midterm price movement.
You only make money by having an edge, an angle on near/midterm price movement.
I believe that there is a misunderstanding in most of the responses. Selling naked options does not only involve risks associated with price variations alone, but it is also involves risks associated with moves in implied volatility and rates of change in implied volatility (and its higher order greeks such as volga and vanna). The price of the underlying can remain unchanged while there will be changes in volatility readings which affect the price of the option. Thus, simply believing that one can sell naked options whether it is by naked positions or delta neutral strategies without have to worry about volatility measures it is just putting yourself one step closer to disaster.
The problem of ignoring volatility alone can turn into a major headache particularly in instances where the portfolio is highly leveraged and the implied volatility surges unexpectedly and keeps on moving.
Naked strategies are risky, but can be just as efficient and profitable when one understands the risks involved and how far one can push the envelope when faced with a tail risk.
Perhaps you should ask your friend to give you a brief explanation on how he plans to control risks associated with volatility shifts. If he cannot provide you one, the I suggest you stay away from this game until you do more research.
Cheeers.
I starting selling naked puts (ES) at the end of 2004, when volatiltiy was low. I would sell puts about 3% OTM, set my stop loss at twice the premium and sit until expiration to collect. In over words, say the premium collected was 4. I would exit when the premium rose to 12, taking an 8 point loss. I was basically laying 8 points to make 4. This was actually a good bet because the chances of failure (based on volatility calculations was less than 10% in most cases). From 2005 to the end of 2006, I had two losses in 2005 and one loss in 2006. So, I netted 24 points in 2005 and 36 points in 2006. In 2007, when volatiltiy greatly increased, I started delta hedging my short puts with short futures. This worked until volatility stayed high. I was taking a beating contiuously entering and exiting my futures hedges at loss. I typically exited the hedges when delta was <0.75. So, that really didn't work. I am not a daytrader, so I tried a couple of other things. For FEB08 puts, I did a "covered" put, where I sold a slightly ITM put and short the future. This was the Friday before the infamous Martin Luther King Plunge. I made money from that, for I closed the trade before it came up to par. I did another trade where I sold some slightly OTM puts, delta hedged, and then covered them when the market plummeted again. I got lucky. this strategy requires watching the market 24/5 and that is not my style. I tried a covered put again for MAR08 options and lost because of the choppiness. So now, spreads start to make sense, especially in high vol situations.
Yes but what if it gaps due to news/event? will you be fast enough? Also stop loss is more difficult on options than stocks due to the wide bid/ask gap.
More importantly what if such event occurs in pre/after hours? BSC announces buy out for $2 when stock is at $30 on weekend..what will you do?
Most people dont mention this but it is true. If you have the discipline to control your position size based on the underlying then writing naked puts is a good way to reduce your cost basis(NOT MAKE MONEY, you still need good stock picking to make money). I use it at times depends on days to expiration etc.., say you want to buy 500 shares of xyz for $50 right now. Instead, write 5 contract of naked $45 (or $50) put, pocket the premium. If you get assigned stock at expiration your cost basis is less due to the premium pocketed, if stock moves up you keep the premium anyway.
The problem is people get greedy and over leverages themselves. You have $20000, you can buy 500 shares underlying. But if you sell 5 contract, margin is only $5000. So they start to see $$$ signs everywhere and sells 20 contracts instead, now when the underlying gaps against you, you are dead in the water with margin call, and forced to liquidity, even if it's a very obvious panic drop/recover event (ie: leh on monday/tuesday)
Yes but how do you know when/if the market turns from downward to upward when you write the option? If you can predict that, you are set for life
Why go naked when you can cap the risk by buying a cheap OTM call above the short leg as an insurance against tail risk?
Guys, just wanted to say a big thanks to all those that share their thoughts and inputs for this thread. Your comments were greatly appreciated and help me understand that this is really not for me or anyone else who hasn't done his homework with options.
Gotta admit there's a certain luck factor with trading in general, but since can't depend on that, best to stick with what I know.
Thanks again!
Gotta admit there's a certain luck factor with trading in general, but since can't depend on that, best to stick with what I know.
Thanks again!
I know this thread is old but here is a relevant paper on exactly this issue:
http://search.ssrn.com/sol3/papers.cfm?abstract_id=959024
His main finding (which contradicts my experience and what I read elsewhere):
long individual stock calls have negative returns and in particular, deep out of the money stock calls have averaged monthly returns of -36.86% over the period 2006-2005. He meaured these using an institutional grade data base of historic options data.
There's lots more detail to the paper but that's the big point IMO.
It sounds wrong to me. Any thoughts from the experienced guys here?
http://search.ssrn.com/sol3/papers.cfm?abstract_id=959024
His main finding (which contradicts my experience and what I read elsewhere):
long individual stock calls have negative returns and in particular, deep out of the money stock calls have averaged monthly returns of -36.86% over the period 2006-2005. He meaured these using an institutional grade data base of historic options data.
There's lots more detail to the paper but that's the big point IMO.
It sounds wrong to me. Any thoughts from the experienced guys here?