@taowave it's all in the metrics of options pricing.. iirc studies have been done showing selling puts on indexes outperforms.. reason being if the probability models that drive derivatives markets hold true, and the data seems to suggest that over the long term they do, then selling puts will beat the market because the puts are overpriced compared to their risk.. yes, you'll not win as much on some big upmoves.. but you'll lose less on the big downmoves.. that risk is priced into the contracts.. but if volatility is skewed to the put side, the puts are more expensive compared to the risk.. one KEY piece of evidence for this is the fact that while there have been studies showing selling puts against an index fund with put skew (like the spiders) will beat the market in the long run, studies done on selling covered calls against index funds with put skew show you lose in the long run, and for the same reason you guys just suggested: you cap your upside too much.. because calls are relative underpriced in put skew equities, you aren't getting paid enough to take the risk.. if shorting a put is just a synthetic covered call, and vice a versa, they should both end up the same.. and if there's nothing to skew, they should both be losing trades in the long run.. but short puts have been demonstrated to win while covered calls have been demonstrated to lose.. because the calls are underpriced relative to the puts.. selling covered calls, thus, will not pay you enough money to compensate for the missed upside potential, whereas selling puts will pay you more than enough to compensate for the missed upside potential.. this means the skew is having the effect on profitability that the probability models project it will.. and if you want an example, go look at the july monthly chain on IWM.. see how much credit you receive for a 30D put vs a 30D call.. also, you're forgetting that if you lose on a put it gets assigned.. you have those shares, now with uncapped profit potential.. so you STILL have uncapped upside potential in your holdings.. i.e., every loss you take on a short put becomes another source of uncapped upside room.. so there's even more of an edge to selling them beyond the skew... if you build up your index positions by selling puts, over time you will a) be entering the stock at cheaper prices and b) building up a core position of uncapped index shares if you don't believe the probabilities MMs use to establish derivatives markets are accurate, then no, you probably won't see any benefit to selling puts.. but if you believe the probabilities add up over time, then it's clear that sellings puts becomes a profitable endeavor..
you are correct about the expectancy.. the reason i suggest selling puts on indexes works in the long run is because indexes have put skew.. if you believe the probabilities that define derivatives markets hold true over time, then puts on indexes are not fairly priced.. also, yes, there is no purpose in actually taking assignment, you're better off to close the put and buy the shares.. but that doesn't mean that selling puts in indexes with put skew on the volatility curve isn't an effective strategy, because, as you say, the puts are mispriced.. if we were discussing something that has no volatility skew to speak of, then no, there would not be a measurable benefit to shorting puts - in fact, there wouldn't be a mathematically quantifiable benefit to trading ANY kind of options strategies if volatility didn't skew to one side or the other.. not counting the overestimation of IV, as that's not a number you can calculate exactly on trade entry.. the volatility skew, that you can measure easily just by comparing strikes.. there may be an edge to shorting options because of the overestimation factor, but that's outside the scope of this convo
how do you sell puts to outperform the market but then also claim selling puts gets into the market at lower prices? how is a put not a synthetic covered call at the same price? how is selling a covered call giving up your upside while selling a put does not? you put way too much importance on skew. What is the difference in dollar terms of a put at its current vol vs if it had no skew? How many points is that worth in the index?
Not sure if I follow. I think most of the time the put skew gives fair put prices. It wouldn't be fairly priced if there was no skew, because large, sudden crash does happen.
To qualify...... I sell puts occasionally. But, I thought funds that write puts on indexes almost always trailed the index in bull markets and performed better in bear markets. See attached for PUTW by wisdom tree. Is there a nuance your explaining that I am missing? PowerPoint Presentation (wisdomtree.com)
it's a bit more convoluted than that.. yes, the velocity of risk is seen to the downside because indexes grind up and crash down.. but look at what indexes actually do in the long run: they go up.. the easiest way to see how this works is to try an ATM put debit spread on SPY then compare it to an ATM call debit spread on SPY.. use the same strikes on both.. you'll notice the put debit spread is cheaper.. where this gets interesting is the implications on probabilistic outcomes.. now calculate the expected return.. to do this, look at the percentage of the spread you're paying to enter (i.e., if you pay $4.00 for a $10.00 spread you're paying 40%) and compare that to the delta at your breakeven strike.. what you will find is that with the call debit spread the percentage you pay for the spread is higher than your probability of breaking even, and with the put debit spread the percentage you pay for the spread is lower than your probability of breaking even.. plot out what happens if you run both trades 100x.. you'll find you're expected to make money on the put spread but lose money on the call spread.. why does this happen? when volatility skews to the put side, puts become relatively overpriced in relation to the calls.. volatility skew is highest OTM.. when you buy the put debit spread, you're selling an OTM put where the skew is heavy so the puts are more expensive which reduces the cost basis for the spread compared to a call spread.. when you buy the call debit spread, you're selling an OTM call where the skew is heavy so the calls are cheaper, which means you're paying more.. the reason selling puts on indexes works is because you're trading in the direction of the trend while using the volatility skew to enhance the dynamics of your trade.. that's where the trick comes in, finding ways to use the skew to enhance your directional trading.. there's also the idea that if you take assignment on the shares you're building an index position, but thats a different topic.. selling puts on indexes has been demonstrated to work while selling covered calls on indexes has been demonstrated to lag the market in the long run.. why? because of the pricing difference.. if you're trading a stock with call skew, the opposite is true.. then, selling covered calls is more profitable than selling puts.. in call skew, call debit spreads yield more than put debit spreads at the same strikes.. the trick is figuring out how to trade your directional bias while taking advantage of the skew... skew doesn't tell you what direction the stock will go, it just tells you how to most efficiently and profitably express your directional view.. you can be bullish or bearish in either type of skew environment...
you are correct, they perform better in down trends and worse in up trends.. but expected values is all about probabilities, and probabilities require numerous occurrences over time, not just in one specific market period.. so when you average out all the down trends and up trends in a 20-year trading career, the edge will present itself as outperformance, even though the actual performance was fairly binary to the market conditions at the time of the trade..
So, you are saying your expectation would be that over 20-30yrs PUTW should outperform SP500. not factoring in fees, etc? do i have that right?