Lots of suggestions but people are clearly not familair with crash scenerios. Your scenerio assumes markets CRAWL lower. Answer whether markets ever gap or crash and whether VOL ever spikes and you will see the stop order method is like catching a falling elephant with a handkercheif.
Markets gap and run lower and fill your sell stop and then reverse and jump higher leading to big losses in the futures. Or, how many futures do you sell stop to hedge the naked puts? What if market gaps down and your futures fill? Do you leave the postion alone or let both run with the wrong assumption you are hedged? Again people assume answers are so easy without giving it much thought.
I had this same conversation with some people earlier tonight. I completely agree with the optioncoach. Ftr, I trade mainly futures and options, but I am never naked puts or calls. You can model the naked sell, premium extraction strategy til the cows come home, but NO ONE has been able to model the extreme event. Last August is a prime example. How many quant hedgies with numerous math phd's had problems performing that month? GS Global Alpha and Renaissance Technologies if memory serves me correct. 95% of the time during situations in which the model complies and the correlations between assets are functional, you will make decent money, albeit you are always limiting you profit by selling short. But when all hell breaks lose, assets will not correlate, hedges don't work and the shite hits the fan. I got stuck in some long positions on MLK day 2008, so the pain is something I am accutely aware of. Long and short of it, if some fund only trade SPY options, which are liquid no doubt, while they will make money following their discipline most of the time, at some point they will more than likely experience a very large drawdown. IMHO, the risk of selling puts or calls naked just doesn't outweigh the rewards. No reason to take the risk to blow yourself up when there are so many other ways to make a buck.
<i>"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."</i> That exact approach works very well selling credit spreads in SPX, XEO or similar indexes. With a credit spread you have defined, capped risk. Naked puts is undefined, blow-up waiting to happen with 100% certainty. A fund that models their cashflow correctly can roll out of two, three or more busted spreads by selling back-month positions in greater quantity to make up for losses. Most of that comes from being well capitalized AND keeping most of the powder dry until adverse market moves happen. If a 25-point SPX credit spread sold for $500 credit goes totally underwater, max loss is -$2,000 per spread. If it has any time = life left at that point, rolling out to a backmonth spread is one possible repair. Holding the max-loss trade is a no brainer... it's already at max loss. Any time remaining offers chance it will go back out of the money (in favor) to some degree prior to expiry. One cannot hold naked options until expiry that are in pain, because the pain is unlimited until they expire. Obviously there's more to it than that. Lots more. Suffice it to say that this approach applied correctly will work with credit spreads. It will not work with naked options forever. Guaranteed, 100% failure lies in wait for those who try. Sooner or later, probably sooner than later.
MLK. The only night in the past year I had trouble sleeping. I remember that Monday night vividly. Asian markets down 5-7% each 2 consecutive sessions and the US market hadn't even opened yet. I was short June SPY puts at time. Not highly leveraged though perhaps 1.5X, and bought them back just before expiry 5 months later. Selling ATM puts without leverage is a valid strategy, however these guys are up 100% and that screams there is MUCH more risk than what they think. It's a great idea until it isn't.
So now ES reached 1230, your stop was triggered. You're now short 1 x 1220 put and short 1 ES @ 1230. And now the next day ES rallies 30 points to 1260. What do you do? Close the future and take the 30 point loss? And what if it drops back to 1230 then afterwards? Short ES again?
I have been involved in trading futures and stocks for the past 15 years; I am quite aware of the Futires markets and the potentially huge swings but execpt for very few occassions I have not seen a market where you cannot get a fill with reasonable slippage. My example was sell 1220 put with SPU8 at 1270; when was the last time there was a one-day decline of 50 S&P points? Tell me, you experts, when was this? What was the biggest gap down in SP futures in recent years? Hint: put up a daily S&P futures chart and put an ATR indicator so you can see view the average daily ranges; do it for a 10-year period. We should be more realistic in these discussions, more attuned to actual market movements, and basing our comments and advice on real life situations. So, I am again reiterating that you can sell SPX puts about 50 points away from current market position and piut a sell stop order a few points above the put strike for protection. You may still lose on a few trades but on most trades you will win IF YOU MANAGE THE TRADE PROPERLY. I do say that you shoudl sell puts and forget about the trade and you will make zillions. Let's be real.
I never said it was EASY. And, that it does not require much work but traders do it and are making good profits. One way out of that trade is when the market approaches your PUT strike you can close the trade and take a small loss (smaller than if you had sold naked puts). But, this may be one of the few trades you lose. All I asm saying is that you can mamage such a trade and come out with decent profits. People do it every day. Most profitable option traders sell puts and sell calls. There is a reason why this is so.