You fail to answer the question on what to do if your sell stop for the underlying is hit and then it rallies in the opposite direction. Shorting the underlying serves only as 'protection' for a naked put position as long as the underlying keeps tanking without retracements. Unfortunately, when markets tank 50 points in a short period of time they can have violent snap backs, completely invalidating your 'strategy'.
Wouldn't the value of the puts you sold DECREASE in value if the underlying snaps back up? Give me a real life situation where the S&P tanked 50 points in a "short period of time"? Short-period is a day, 2 days? Would you sit on your butts while the market was doing all these wild movements? These big swings give you even more opportunities to manage the trade.
Thanks to everyone for contributing to this discussion. I have a bit more information. The fund has been in existence for 5 year now. 25% of the fund are owned by 3 people who run it. They were using leverage of 200 options contract per 1 mil, and have recently reduced it to 100 contracts per 1 mil. Also, another protection strategy that they use is hedging with futures. They are doing it full time and monitor positions every day to be able to react if things go wrong. Thanks, redduke
You're going to be ass-canned if the vola you sold is under realized vola on spot. Simple as that. It works until is doesn't. You will be selling the low bid and buying the peak offer on your hedging.
Again, you are being vague and uttering warnings but not gettting in more specifics about the trade; Example, if the market snaps up 30 S&P points, you can sell Far OTM SPX puts at say, 1200? In other words, you can manage the trade properly and escape with a small loss, or even a profit, even in the cases where the markets move big against your naked puts. People do this all the time and make a lot of profits. A few are crushed, but tell me, in what aspect of trading is everyone profitable? Generaly, in all trading, and in life, you will be screwed if you don't manage properly. Not just selling naked put options.
I haven't seen anyone mention Oct. '87. Does anyone imagine they could safely manage such a position through an event like that? Will it happen again in our lifetimes? I don't know, but I'm not willing to take a position in which a single event - no matter how unlikely - would wipe me out.
You see, with your theory of 'trading around the position', why would you sell the puts at all? If you think you can foresee the market direction and successfully trade around major market swings, why not simply trade the underlying outright? Why sell puts in the first place? I sell options myself in one of my strategies. Usually I allocate only 10-12% of my capital to this strategy. IMO the key is not to over leverage and to have modest return expectations and not to panic (i.e. try to hedge, try to 'trade around') once a position goes against you. If a position ends up going against me at expiry I take the loss. I don't average down or add 'hedges'. Period. The returns are (for me) somewhere in the area of 15% annually + interest from the cash collateral that I keep. Nowhere close to the 100% the OP was being presented with. However, option strategies can offer uncorrelated returns to e.g. equity L/S strategies that is - rather than the mere returns - what makes them attractive IMO.
FYI : this is the September SPX chain at the CBOE site: http://delayedquotes.cboe.com/optio...CLASS=IND&ID_OSI=10614550&ID_NOTATION=8941848 Look at the puts with 700 to 1150 strikes - sellers are reaping huge profits on these; good volumes and open interests; at current market of SPX 1270 they have over 120 SPX points to manage the trade. Most of these puts may expire worthless; in case market moves lower you can sell more far OTM puts and sell SPU8/SPZ8 futures, or close trade with a small loss or profit. Strike Price Symbol Last Trade Change Bid Ask Volume Interest 1,000.00 SPQUT 0.30 0.00 0.20 0.45 3,397 172,174 1,025.00 SPQUE 0.25 -0.15 0.25 0.50 1,177 38,888 1,050.00 SPQUJ 0.50 0.10 0.40 0.55 100 121,130 1,075.00 SPQUO 0.80 0.15 0.60 0.95 7 212,984 1,100.00 SPTUT 1.30 0.25 1.00 1.30 7 267,218 1,125.00 SPTUE 2.00 -0.07 1.50 2.00 726 91,062 1,150.00 SPTUJ 3.00 0.20 2.55 3.20 358 355,783 1,175.00 SPTUO 5.50 0.70 4.50 5.30 18 74,383 1,200.00 SZPUT 8.00 0.50 7.80 8.60 2,003 155,771 1,225.00 SZPUE 14.50 2.50 12.10 13.70 626 99,119
I am happy to entertain you. We would also welcome an intelligent response to "sellers of far OTM puts" e.g. SPC 800 to 150 are reaping huge profits, as they have been doing for the past few years. Put buyers of these far OTM options are simpletons and fools who are easily parted from their money. This is a fact. Most option buyers and their money are easily parted.