When I first started trading options, I was only doing spreads. Here is where I ran into issues: 1) When your spread goes ITM, it's going to cost to roll. Last summer, I had a number of spreads go ITM, and it took 3-4 months of rolling the entire spread before they were OTM. Each roll was a debit. Subsequently, to manage the margin, you could only open spreads for a portion of your available margin in order to handle situations where you go OTM. 2) With spreads, you can make your short strike further away from ATM, but to generate significant income, you have to open a large enough pool of spreads such that if you wanted to close some of the long legs, you don't have enough margin such that you can close all of them without also closing the short legs. So the spread legs are paired together. For example, right now I have 24 naked puts on RUT at $650 strike that generated around $22K of income when they were opened. To generate the same income with $620/$610 bull put spreads, I would have had to open nearly 200 spreads. With that much leverage, it gets harder to roll or adjust when the market has moved aggressively toward my strike. However, with 24 naked puts, when the market does get closer to my strike, it's a two legged roll that generates income to go further out and down. I make sure that I never open too many put contracts such that I couldn't continue to roll out and down.
Rolling equates to averaging losers in Delta1. I don't do that, it's foolish. You're not arguing utility... you're arguing that regT/variation margin/haircut keeps you out of trouble. Please don't state that rolling a loss, "generates income" as I just ate too much rib eye. I'd like to keep it down.
Why not simply straddle off a portion in short futures or a short RUT synthetic? It's safer than naked and you reduce your haircut. Say, sell three ATM synthetics against your 24 naked puts (8:1 favoring puts). Sure, you're short $300/point, but you have a reasonable chance of earning on the primary and the hedge. If wrong you lose a lot less and will not need to roll. The rationale is that you're already short so much skew (edge/ATM) that you can amply afford an initial hedge rather than potentially "buying the high" (in vola on the naked short -> forced roll). I have what I believe is a preferable skew-isolation trade; it's extremely robust, fairly selective (8-10 trades/year in monthlies), and doesn't involve short futures or the synthetic.
Not sure I fully grasped what you are suggesting. You are saying have 24 naked puts along with 3 ATM synthetics (3 ATM short puts + 2 ATM long calls). The synthetic would eliminate the need to open naked calls OTM, of which I have about 3x the number of naked puts. The benefit of naked calls here is theta burn, along with gains that discount losses on naked puts if the underlying shifts down. With the synthetics, the underlying must rise for it to gain, but with pure naked calls, the underlying can remain flat and gains over time still be had. I might be missing the complete picture of the positions you are saying should be constructed.
Synthetic short. Short 3 calls, long 3 puts, same strike. It's a hedge. Equivalent to 3 short futures.
Thanks for clarifying. I ran some numbers comparing two sets of positions - all Jul 19 expiration: 1) 24 naked puts, $650 strike; 72 naked calls, $850 strike 2) 24 naked puts, $650 strike; 3 ATM synthetic shorts, $770 Here is what I found: Option A has a higher overall return during all weeks if the underlying stays between 700 and $780. In the last 2 weeks until expiration, Option A has higher returns if the underlying is between $700 and $830. However, in all situations and time periods, Option B lowers the potential loss (significantly) if the underlying has a strong move in either direction beyond $700 and $830. So, going with the short synthetic lowers the price before which you would suffer a total loss. In exchange for this, you give up potential profits on the upside. If you are in an uptrending market, Option A with it's high number of naked calls could go negative for a period of time, but if the market settles just below your strike at expiration, then you will make a much larger profit. The total portfolio margin committed with the synthetic option is significantly lower - you would maintain a high excess liquidity because you don't have to carry the cost of the naked calls in exchange for this. I think this approach makes a lot of sense if you have a strong sense of direction of the market. If it's a down trending market, like we are witnessing now and you believe the market will be 5-10% lower than where it is today, then you make larger profits with the synthetics at a much lower margin reserve. However, if you think the market is going to be neutral, you make more with going the naked route. I haven't given any thought on how you might adjust the synthetic if it goes against you. With the approach that I have been using, if the market slowly melts up to around $830 by expiration, I will still have made all of the call profits. But with the synthetics, my overall portfolio will be about break even.
You can't get the math right and I don't have a lot of time to revisit it. The loss to hedge is $18k at 830... and therefore you still earn $4k on your short puts. I have no idea how you arrived at an net break-even on the combination at 830 RUT. So short a 2-lot synth and you retain nearly half of the credit at 830 RUT. The rationale is that the skew is bountiful, so why not hedge as OVER HALF of that credit is due to asymmetry (risk-reversal prem on put strike)? Spend less time calculating your margin headroom and more time looking to hedge. Good luck shorting naked puts.
My numbers were accurate - and I approximated right at $830. I plugged everything into TOS Risk Profile. The variance came from having a synthetic that was slightly off strike with the long put at $765 and the short call at $770 to make the short synthetic a net break even at the time it is opened. To be specific - TOS says that I get about $2.5K total income at $830 at expiration, and break even at expiration is $837 before any commissions. You have given me some homework to do - appreciate the inputs. Definitely some stuff to think through on how I am structuring components.
Don't use a split-strike. The synthetic is equivalent to the futures, but will assure that you're getting a reduction in haircut. I assume these are AUG puts? You never stated it. The AUG synth is trading 771.00 mid, so a $17,700 loss to hedge at 830 RUT. The synth can can't get any worse, so my numbers are good. So yeah, your (or TOS') maths are wrong.
Dael, sorry for the delay , I was in holiday. Yes I am on paid subscription with MRCI. Thanks for the suggestion. HR was already in my list for starting a trial period in the next weeks.