Let's say i'm an investor, not a trader. I want to own XOM-- and it's too expensive for me. I decide to sell $62.50 puts.. if they are exercised so be it, that was my intention initially if i dont get assigned the shares, then i get the premium and i keep doing this strategy until i am assigned -theoretically, i will likely be assigned (black swan), but the avg. price will be $59-$61 since the premiums collected will lower my avg. price. i for one would love XOM at $61 (LONG TERM HOLD)
What does the portfolio look like? It's a portfolio achieved from adverse selection. Consider one who is writing covered calls on owned stocks. The good stocks that rise are called away (no upside participation) and you get to keep anything neutral as well as the lousy ones which drop. Since a naked put equals a covered call, it's the same end result. The naked put writer doesn't participate in the upside and BUYS the ones that drop. IMO, the primary reason for writing naked puts is because you are willing to own the stock at a discount to current price. But that doesn't change the lousy risk/reward ratio and AFAIK, there are better ways to chase premium. And to further contradict myself (g), I sometimes sell slightly ITM NP's the last few days before expiration on stocks I like that are near support and appear to be bouncing. But the amount of rope they get is very short and it's an intraday trading strategy. I don't want to invest via them.
Repeating the strategy until assigned may be problematic because in a rising market you'll get bupkus for that 62-1/2 strike or you'll have to lower your standards and raise the strike sold. The other problem is that it's not rare for XOM to drop 10 pts or more over 2-3 days - and it's a low IV stock. A Black Swan could be even worse. Yes, you're absolutely right that as an investor, if assigned, you acquire the shares at a more favorable price. But the question is (rhetorical), is that the best way to acquire stock and can it be done with less risk?
I'm not saying you can't do what you propose. I'm only suggesting that 1) It contains acute risk which according to MPT you're not getting paid to take (yes I know there are some trip wires here when you begin to involve derivatives and so consequently I'll leave this as a 'weak' argument) 2) It can be a relatively inefficient use of capital and this should make both investors and traders unhappy. Thanks for your specific example. Lots of people don't put the trades up (as Capt. Beatdown earlier insinuated), but here are my thoughts. You want to own XOM. I'm assuming (I'm probably wrong) it's not totally for the dividend yield as you're pretty specific on your price targets, so I'm guessing you're after a specific move in the underlying. Stocks are up, bonds are looking better, and the only thing down and out is the big three media and if they start a libertarian anarchy channel, their recovery probably won't be long either (maybe they'll take a cue from MTV). Anyhow, I would hate for you to miss the move you're looking for, but you don't want in the stock because its probably at a higher point in its cycle, fine. Suggestion: Why don't you short a 65 put and long a 72.5 call (JUL set). This will give you price protection for almost 5 bucks, and still allow you some profit if the asset increases. You can still fish for sharks in a rubber raft if you like. Just selling the 62.5 only gives you about a 16% probability of picking up the stock in the current vol range. I'm not sure if I would place my capital with an investor who valued the strength of their decision to own something so weakly - and here's what I'm really arguing - 16% , or .60 for the JUL set is not much premium for a consolation prize when guessing correctly and playing the move incorrectly. I would need more premium for my decision, or a hedged bet, and that way if XOM (or any stock for the matter) goes down hard, you won't get creamed, thus it'll take a lot less capital and you can trade more, and you can worry less, and you can place these types of trades on both the long and short side of the market, and you can send me $50.00 dollars a month for my news letter which I write drinking cranberry juice while in my underpants... just kidding Here's what I would do, and have in the past. If I thought a security was going to a certain price. I would sell premium on the other side by selling a vertical one or two strikes OTM. There is enough meat in it to make it worth while, and you'll be backstopped incase the market creams you. OR, site back and value your time off the market in a risk free investment, when, if XOM gets to 61, but the stock and sell a call against it, you're going to have the same risk curve, but if the stock gets called away you could make 4-5 months put premium in 30 days, possibly sidestepping unnecessary risk. Much of my thoughts are not technical in so much as perspective. For instance, RedEye says: there is no such thing as an 'investor' in a daily mark-to-market arena. There are speculators and hedgers. Speculators care about the direction of the underlying asset, hedgers care about metrics of their underlying instruments, specifically options in this case, and the hedgers goal is to work to eliminate directional risk, as well as a host of other risks. If you want deltas, direction, your deltas with the least gamma rent will be the underlying. If you are instead seeking non-direction with a possible cherry on top, consider imbalanced hedged positions or something of the sort. Long premium is no fun, consider a put ratio write for a credit. OR consider going long a heavy delta (70ish) option 3-4 months out, and then selling front months against near the money in order to finance it. You can slope your curve according to however bullish you are, and on most months it'll pay for itself with better return, plus VOLs are generally in your favour. You can slap these on and ignore them if you want until the roll ahead, which I would rather see you do than ignore a naked long / short put. Same idea in lowering your average price as with XOM shares. Spec and hedge can cross over if one were to play a steep skew around the money and say, buy one ATM put and sell one OTM put. This trade is bearish, but its advantaged in that you're buying low vol and selling high. Anyhow, best of luck. RE
I'm not trying to shoot down the idea, but equities are becoming more closely correlated on a daily basis, especially when you consider the international scene. I think that if you're taking on share risk - its a de-facto bull bet, and I guess I would just like a bit more control as to when I'm forced to make that play. And while the writer does buy the stock which drops, he must consider that on a X axis line, he is willing to buy a stock on any price ranging from 0-to-SRIKE SOLD. Surely, it's not bad sounding that you'll pick up XOM at 60ish, but all considered, I really think that if one is using adverse selection, it's really just a longer term stat arb trade these days and it requires a very sophisticated trader.