CS, maybe a step back. Short strangle means you have limited profit for unlimited risk, hence your hedging questions. The main thing that strikes me, is that is a strategy for low vol outlook, which we are not obviously in at the moment, so why would you look to use a strategy that is not in keeping with current market conditions. Just wondering? J_S
You have me thinking again, which is good. If the put price is up, then the call price is down, so you are going way out to pick up time money, and even though you balance with deltas, the fact remains, you are selling one leg at the wrong time, relative to the other. I think, as mentioned, with any type of trading, timing is crucial, and I can not see math calculations reducing your risk better than proper timing. Just my thoughts, interesting to see what the option traders think? J_S
I monitor a number of hedge funds and CTAs that sell credit spreads and/or naked options in either RUT, SPX or ES. I have also raised money for a few of these. They lost between 9.3% and 1.4% in January. One made 0.70%. When you consider how bad January was, that's not too bad. It is a viable strategy as long as it's not done randomly and you have a plan for when it goes against you. During good months, they earn between 1% and 5%. (After all fees) The problem is simple. There is a lot of risk. Most of the risk comes from liquidity risk. During times of stress, these markets can get very wide and illiquid, just around the time you need to hedge or cover! The clearing firms and FCM have been cutting back on this type of strategy by either not opening accounts that do this or by putting restriction on this strategy far higher than what the OCC or the future's exchanges allow. The clearing firms call these "add-ons" or risk requirements. Eg. INTL FC Stone shocks a a portfolio of futures/options +/-10% and +/- 20 Vol points. Apex Clearing, for SPX, rather than -8%/+6% shocks the OCC allows, uses -15%/+10% 1X your equity, -25% 2X your equity and -50% 4X your equity. This will only get worse over time. This makes it very hard to build a trading business with this strategy. Bob
I think I don't quite follow or comprehend the description and its questions, perhaps due to my limited understanding of options trading, especially short selling naked. However, I would think, in general any work-in-progress adjustment suggested/implemented on currently losing options in naked short positions would not be much helpful (if not getting worse), nor better than simply closing the losing options for cutting loss. Of course, there could be exceptions (probably in this thread) beyond imagination - that would make a trader one of the best options-sellers on earth! Just 2 cents!
My understanding is that CS wants to capture time decay, which is a very valid approach, as I done it in the past, and seen how good it actually is. He has covered some of the basic requirements, as in only trading European Style if selling options, as they can only be excercised at expiry. However, as with all trading, he is trying to come up with a way to reduce his risk, with a strategy that has unlimited risk, and this is not easy, unless you fully understand volatility and probability, for, you are competing with those who spend millions developing software with the best math minds out there. I think his approach is wrong, and he should be very selective when he sells for time decay, and always cover your naked position with another strike, as this is your stop loss, which you should never trade without. I done it before, so I know a small bit about it, but as always, I wish I knew then what I now know. Never tinker with things you do not fully understand, as you will get caught out if you panic, and do not know how to adjust losing positions correctly. Overall, it is a money maker, that is for sure, but you must know exactly what you need to do when price moves against you, and it then just becomes a matter of time, which is the whole purpose of selling options. And never get greedy, aka, overtrading J_S
If you do some digging around you will find that there are many traders who think this way, then end up getting their accounts blown by, as some previous posters mentioned, a black swan event. If ur naked selling there is no way of getting out of this. Now this may never happen to you of course. This is the risk you take. I had a friend who got carried away by the whole idea of selling options and got caught. He lost 3 houses in the process. I'm in Australia and the biggest broker here in Australia (BBY) recently went under (administration) because of is clients getting carried away by option selling and didn't have enough $$ to cover their trades. I'm a buyer only, when I first started trading options, JPmorgan was in the process of losing a stack of cash because it had entered this trade on something ( I can't remember ) and they couldn't get out of the trade. SO I got scared and limited my risk to my own account. U gotta remember you could loose a lot more than your balance selling to open. I don't care what ur strategy is. Even with the ES something could happend over the weekend and you could get a crazy gap down.
True! A very valid approach to unlimited risk! Read: A way potentially to produce possibly several times more than the risk (that at the time of hedging with futures)! The run-away short options leg, and two futures contracts, separately! Even without needing a black swan to appear! I think the approach could be very wrong on several levels! Read: In short selling naked options, (only me but no others) knowing how to adjust losing positions correctly - Very very lucky so far! Just 2 cents!
There is no such thing as "capturing time decay". It falls under the same ridiculous chapter as "trading for income". These are all titles of worthless books. ALL options are priced on their expected net present value. They are either trading above or below their fair value. How far out of the money they are matters not. There is nothing to "capture" unless the option is mispriced.