It is kind of a stretch to state that a risk model takes into account a black swan event when such event is completely unpredictable as to timing and magnitude. If risk models could factor in black swan events then we would have fewer blow ups.
Boy, this seems like great strategy if you are the "hedge fund" mgr. Imagine, in a bull mkt. Earning 2/20 commission if your the mgr. You use leverage 5:1 or greater on somebody elses money. When you are right, you earn massive commissions/salaries and are the toast of Wall St and your investors. Then eventually, inevitably, you implode. On a major event. Everything is gone... except of course your previously earned commissions/salary, which is safe assuming the fund mgr didn't invest it back into his fund. Boy that sure sounds familiar. Real estate/mortgage bubble. Something has got to change. A one strategy fund seems destined for destruction SP
If I am not mistaken, what he means to say is that if the trader is assigned those puts, he would be buying the underlying at a cheaper price than if he had bought it at the price level when he first sold the puts.
agree. the models stress test the scenarios and point towards a certain leverage, not foresee 10 sigmas events, per se. and this is exactly allows the fund to survive in such scenario. on the other hand, the risk framework also directs the management to enter into adjustment strategies , ie. protective puts, under certain circumstances, such as sudden increases in vola or other meaningful events. my point was, professional short premium inventory management is far from hitting the sell button and wait for the expiration to cash in, sort of thing.
a) Once it approaches the strike, the price won't be 3 but rather something like 30. He sold it for 2 and he buys it back at 30. Taking a loss 15 times the size of the potential gain isn't exactly a favorable risk/reward setup. b) His theory assumes that markets move downward in a controlled, slow & steady manner. What does he do if there's a Monday morning gap down like on Marting Luther King day this January? That one wiped out many many leveraged naked put sellers.
Let's say you are writing naked SPY or SPX OTM puts. For each put written, put in a stop order - ES or SP futures, that will kick in if the market tanks, especially during overnight session. e.g. sell SPX 1220 puts Put in a sell stop order at 1225 or 1230 etc; this value will be estimated based on the PUT strike. You can adjust the stop as time goes by.
and what will you do when your order is not filled on the hot knife thru butter? jump out the window?
Sell Stop FUTURES, surely we can get a fill on SPU8 at 1225 or nearby, if markets tanks to this level, near to the PUT strike. e.g sell SPX 1220 put; S&P futures is now at 1275; put in sell stop SPU8 at 1230