Like you said, it depends.......But in general, twice the premium would raise red flags for me. It really depends on what the underlying is. For example, Corn will NEVER go to zero because once a certain price level is reached, China and other countries will start to buy at large quantities thus establishing a floor on prices. And corn will not zoom to $10 because as prices move beyond the $7.50 range rationing will take place. Instead of corn, farmers and large companies that use to corn to make food products will switch to a cheaper alternative such as wheat, also China and other countries will stop buying thus forcing prices to stabilize or drop back to more normal levels. So if I am short corn calls or corn puts, I may risk to triple the premium or even allow the options to be exercised and turned into a futures position if my strikes are around key fundamental levels. I would only do this if I am very certain that prices will reverse themselves soon. With AGs, limit down days are sometimes followed by limit up days or vice-versa. An example would be a weather scare, prices will go limit up with reports of possible crop damaging weather but after a few days, it turns out that the damage was avoided and then prices drop limit down. If you didn't look at your screen for a few days, you may not even realize that there was so much volatility. Also how close to the money and how many days until expiration comes into play. I usually choose strikes to strangle that are very far out of the money that has 60 to 90 days until expiration. Should the premium double on one side (it would require a strong sustained move in one direction), it usually means the fundamentals have changed and it is probably wise to exit the position to reevaluate. The loss would be cushioned by the gains on the other end of the strangle. By and large this has worked well in limiting large losses. Remember that with option selling, you will be profitable with 90% of your trades, its the 10% losers that must be managed. So if you can keep those losses to a minimum, you will be very profitable. In the end, each trader must do what they are comfortable with.
Impressive. Most option sellers I dealt with as a market maker did not fare well (I can't imagine how you could have done well being short any risk premium in the Fall of 08). I do like selling vol myself, but on a very select class of assets where vol is unreasonably bid and I have some many other long risk premium bets on that it's a small line on the total set of strategies. The short convexity aspect bothers me too much to do it as a main business - you eat like a chicken and you shit like a pig.
Thanks. But I do not want to brag because I know most traders got killed in the 2nd half of 2008. Honestly, I got lucky. Heading into July of 2008, I was quite profitable selling strangles on ES, CL, and Corn. But starting in mid July, I started to take losses when the premium on the puts started to double quickly. At one point, I took a loss four straight times on four separate ES strangles from mid July into August while also suffering the same fate with corn and crude oil. Previous to this, I have only suffered back to back losses with ES strangles twice in three years. So to lose four straight times was very unusual. Luckily, each loss was cushioned by the calls losing most of their premium. But I took a pretty good draw down during those six weeks. I could sense that something was wrong but of course I had no idea how bad it would get. Heading into September 2008, I decided to change my strategy a little bit based on what happened in July and August. I waited for a relief rally after each large sell-off to write an ES ratio credit spread on the calls only. On a few instances the premium on the calls that I sold went from 9.00 to like 2.50 in a matter of a day or two. I would take my profits and wait for the relief rally and was able to once again sell the same strike for around 7.50. This was how I survived in September and October of 2008. Then in November of 2008, I saw a segment on CNBC about the opportunity to sell naked put options on some severely beaten down stocks. I did a little bit of research and decided it was worth a play so I sold naked equity puts for the first time on C, LVS, and M. Those stocks were trading so close to zero that I was not afraid to have the shares put to me. And I figured that if I had to buy the shares, I would then write covered calls to collect even more premium. For November and December, I collected close to 35K worth of premium.
MJ Hopefully your Met fan as well, apppreciate your posts your knowledege on selling options is far superior to mine. I've been trading about 10 years but only selling options the last 3 as you say not the holy grail but it certainly provides a steady income I try and sell 3 to 4k a month in premium I certainly could sell more but I tend to er to the cautious side. thanks again for your posts
It doesn't matter whether you're "on the cautious side" and "only selling $X in premium" .. There is no default edge generated by writing options. It's a directional vol trade, whether you know it or not.
Phil & MJ, Great insight reading your posts - very happy to see this thread started. I've been selling options for just over 2 years now on commodities, and also index options. MJ's posts sums up pretty much my thoughts on using this as a trading strategy although I don't use this exclusively. I'm trading 5 different trading strategies and I find option selling to be the most consistently profitable, but only 2nd most profitable overall. As for managing stops, I use a variety of methods, most have been mentioned previously in this thread. Anyway, glad to see there are a few more of us option sellers out there. Fair winds and following seas to us all!
Oh. I see. Perhaps this discussion will dovetail well into a relevant book or training course recommendation.
Physicsman Thanks for your post glad to hear from fellow sellers, Again I sell mostly equity and ETF options I understand the maintenance requirments on commodity options are much less per contract then equity options. Can you give me an idea of what those requirements are, just curious. thanks agin for posting
I've not traded equity options but I would think they are less than for futures options, especially if you are using Interactive Brokers, since they require much greater margin than the exchange stipulated minimums. Also, for commodity options the maintenance margins change each day based on the movement of the underlying future. For example, if they move closer towards your strike the margin increases and decrease when it moves away from your strike. As an example, I sold a Wheat July 900 Call on 28th Feb and the Margin was $908. Today the margin is now $146 because it is so far out of the money and theta has eaten almost all premium. For Gold and Silver though, the margins have been jacked up to ridiculous levels, something like 12,000 or 16,000, I can't remember!! As always, the marging also depend on the volatility of the market, so margin for August Crude Oil puts are $1662 right now. You should be able to find the margin requirements for all the markets on the relevant exchange website: CME, CBOT, NYMEX and ICE US (the old NYBOT). Hope that helps!