Insurance can be a negative sum, when a hurricane hits and the insurance company goes bankrupt, everybody loses. The company is unable to pay out the claims loses all profits (bankruptcy) and the insurance buyers don't get the coverage what they were promised (all their paid premiums went for nothing). How can we duplicate it? You are long on stock X, but keep buying OTM puts, just in case the stock tanks.
Insurance companies make money in a variety of ways. Here's one. A coupla months ago I started a chain about hedging an existing appreciated portfolio with index options. That led me to discover some different index annuities that provide a profit limit cap along with various amounts of downside protection. AXA offers them with 5 year duration. If one chooses the one year segments on the SPY with 10% downside protection, the cap as of 2/23 is 6.6%. I can replicate the above with options for Jan 2019 and I can achieve a variety of different caps and downsides by varying the strikes. The closest to balanced was 10.9% (call it 11%) of downside protection with a cap of 11.0%. Without getting into the nitty gritty details of how the insurance company arbs the difference, they are selling a policy that pays less than the actual synthetic pays and risks less as well, so they are arbing the difference. If you can find people to buy something from you that has an inferior payout and greater loss potential than the synthetic equivalent then you will be able to duplicate the insurance companies' approach to buying and selling options. (And FWIW, by giving up 3.3% of the cap, I could achieve 20% downside protection which is double what they offer with 7.7% still better than their one year cap of 6.6%).
Interesting, I am going to go through your logic and see where it leads me. A quick question: How is that compared to what Pekelo said, simply kept buying OTM puts? Regards,
Yes, but you will sleep much better. (no such a thing as free lunch) In an ideal situation stock goes up more than the cost of put. But because of the puts, you sleep well. Also if dividend paying stock, you get the dividends... Going back to the insurance analogy: The stock is your house. The put is your fire/flood insurance. In a general housing market, the stock/house value slowly increases. The dividend is your ability to live in the house or renting the house out (rental income).
there is a small theorital edge in selling options but probably not worth if you consider the tailrisk
I’m up 26% just daytrading options. I don’t write. I don’t do weekly’s. Just month of February. I don’t think option pricing takes into account support and resistance in the underlying.