Are naked puts really this safe????

Discussion in 'Options' started by RedDuke, Aug 20, 2008.

  1. RedDuke



    I have a question about naked options, in this particular case – naked puts. I pretty much know nothing about options besides general terminology. I attended a meeting for capital raising for 1 small fund (around 10mil under management). The only thing they trade is options on S&P 500.

    The manager said that they utilize various strategies which are very safe and depend on market conditions. The only danger, according to him was the leverage they employing, but let’s set this one aside for now. When I asked him about how they trade, he said that right now they basically sell out of the money naked puts. I immediately asked about the danger of such strategy, we all heard many stories about people loosing everything by trading this way. This is what he said:

    They are not risky because you can always cover the one that you sold and sell the following month thus not having a loss. Basically he would sell October Put for $2 and if the price would approach the strike, he would buy back this put for 3 and immediately sell November Put for 3 and thus protecting himself. He did not loose anything except for commissions. It seems like average down, but since this is index it is not as volatile as stock.

    What do you guys think? It just sounds weirdly simple. Can you please share your insights.

  2. empee


  3. Selling naked puts can work for while, but you don't get something for nothing. He is kinda saying there are $20 bills in the street. I am an option trader on the SPY exclusively and know it well. There will be a time when those on the other side of that trade will have their due. If there is no leverage, then that's a different animal.

    What if those short October puts sold for $2 had to be bought back for $25?

    It'll work great until it doesn't, then a valuable lesson would have been learned.
    I learned it years ago.
  4. RedDuke


    Can you please explain.
  5. Look at a 10 year chart of the SPX. Can you spot the years that naked shorting index puts would have wiped you out?

    Too much risk for way too little reward.
  6. I think "collaring the cube" would be a better strategy.
  7. Selling naked puts is the same as simply writing covered calls if quantities remain identical. In that sense, they are no more risky than a covered call unless you increase the leverage. I would argue that you are actually better off selling puts for a couple reasons if you are someone who is bent on a covered call strategy.
  8. Nickvac


    Sounds a lot like a Martingale type of system. Works if you have an unlimited cash flow.
  9. Sounds like a bunch of idiots started a fund. Anyone who thinks naked options are not that risky because you simply buy them back before you incur a large loss knows so little about the markets, it rises to a level of negligence that the SEC should get involved in. Anyone with money in this fund should withdraw and these managers should be fined by the SEC for incorrectly stating the risks of the strategy they are employing.

    Amazing the stupidity of some people (referring to the fund managers, not the OP).
  10. RedDuke


    They are 100% up for the year. Do you mind explaining how they can get wiped out assuming they are not going to repeat it indefinitely if market seriously goes down.

    #10     Aug 20, 2008