How about this strategy?

Discussion in 'Options' started by Eliot Hosewater, May 20, 2006.

  1. I'm looking for opinions on this strategy:

    Pick stocks out of the 30 DJIA with the fattest premiums. I think there are about 20-25 with premiums large enough to make it worthwhile.

    Sell just OTM naked puts on them.

    For protection buy DIA puts. I would need to work out some formula for how many at what strike.

    If you get assigned then start selling covered calls.
  2. bvam1


    why not just buy a lower strike put instead of working so hard to figure out how to hedge it with DIA put.
  3. OTR


    There is nothing wrong with that strategy, providing:

    1. You are selling naked puts on stocks you don't mind owning, at the strike you are writing.

    2. You keep enough capital in your account to buy the stocks if you get assigned. (Also check with your broker about margin requirements.)

    bvam1 is describing a collar which is a common way to go about what you are proposing. It will limit your downside, but will also decrease your return.

    Ken Trester covers this topic in The Complete Option Trader. I have read this book and am about to review it on my site (I think it is a very good reference book for Options strategies):

    There is another book that I just received from Amazon but haven't read called "Covered Calls and Naked Puts". I will also put a link to it on my book page.

    I like to write covered calls for income. I pick stocks that I like for the long term and stick with them as they go down. If they go down, I simply write more calls, decreasing my cost basis each month. Doing this, it's quite feasible to build a portfolio of quality stocks with cost basis of zero and below. Therefore, I don't use collars.

    Keep me posted on you thought process. I am very interested in it.


    Option trading information and tools the pros wish they had! A former Chicago Mercantile Exchange employee reviews stock option trading software, books, and web sites and online income opportunity.
  4. Thanks for the input.

    To answer bvam1, one reason would be to save on commissions. Instead of buying maybe 20 individual puts you only buy one DIA put.

    Steve, I'll check out the books you mentioned.

    Maybe I'll paper trade this for a while.
  5. You're betting on the correlation by doing that. What happens if there is specific (bad) news about the company, which does not affect the rest of the index?
    I would rather take a basket of stocks with fat premiums and test for the stability of the correlation between the basket and the index. That way you are still selling fat premium/buying thin index premium, but at least specific company or industry-related risk is diversified.

    edit : just realised by reading your first post again that that's in fact what you plan on trading (basket against index). Good luck. Good idea to buy lower strike puts to hedge the naked ones, as mentioned on the thread.
  6. segv


    You almost invented a well known strategy called dispersion. Google for "dispersion trading" or "volatility trading". You will find that the formulas have already been worked out for you. In a nutshell, dispersion leaves you long or short the correlation. It is not for the fainthearted or undercapitalized. See this article by FDAXHunter of Wilmott forum fame: Files/2/Dispersion - A guide for the clueless 1.1.pdf

    Running a short dispersion book, as you are suggesting, leaves you succeptible to sigma events in the individual components. That being said, I know several traders who are running these books with success in this low volatility environment. Historically however, market conditions have favored long dispersion for some good reasons that will become obvious with your research.

  7. Thanks for that link, segv. This paper is fantastic.:)
  8. Good material you got there, segv, thanks.

    Are there any elitetrader members who have sheep, as a matter of urgency? Thanks.
  9. segv


    You are welcome, but do not thank me, thank FDAXHunter. I do agree about the quality. If only everything could be written so succinctly. :)


    PS: Baaaaaaaaaaaaaaaaaaaa
  10. OMFG ROFLMAO!:D :p :D
    #10     May 21, 2006