My approach to selling puts.

daytonabeach83 · May 24, 2021

destriero said:
All that I am stating here is that there is no vol/skew component to the arbitrage relationship. Even in RUT/IWM. It would help to price things in vol in lieu of premium. Anyone here can find a mispricing off of live quotes, but execution is another matter.
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to the first, i totally get that.. i guess what i'm trying to get at is that if you're doing directional trades with risk, not arbs, then the skew can still be used to achieve positive expectancy in your trades, at least in my experience..

to the second, i haven't had any issues getting things to execute with those "skewed" prices.. sometimes you don't fill quite at the mark, but if the trade has a $1.50 positive expectancy, it isn't killing you to fill for a $1.45 PE..

again, as an arb thing, i totally get that it's a wash.. but are you saying there's nothing at all to using skew to create positive expectancy in defined-risk directional trades? and yes, i know that PE in and of itself is not the holy grail.. more a, "don't take the bet unless the odds are favorable" type thing, but it doesn't tell you how to actually win the the bet..

daytonabeach83 · May 24, 2021

destriero said:
The thing you're calling skew is (YOUR) bad mark. You need to understand synthetics and their role in maintaining liquidity. It's not so much that they trade, but how prices move on the assumption of a delta-lock.
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even were you to fill your long at the ask and your short at the bid on that IWM example you'd still have a cost basis reduction - again, obviously irrelevant if you're shorting the reversal, only speaking on directional stuff..

destriero · May 24, 2021

daytonabeach83 said:
to the first, i totally get that.. i guess what i'm trying to get at is that if you're doing directional trades with risk, not arbs, then the skew can still be used to achieve positive expectancy in your trades, at least in my experience..

to the second, i haven't had any issues getting things to execute with those "skewed" prices.. sometimes you don't fill quite at the mark, but if the trade has a $1.50 positive expectancy, it isn't killing you to fill for a $1.45 PE..

again, as an arb thing, i totally get that it's a wash.. but are you saying there's nothing at all to using skew to create positive expectancy in defined-risk directional trades? and yes, i know that PE in and of itself is not the holy grail.. more a, "don't take the bet unless the odds are favorable" type thing, but it doesn't tell you how to actually win the the bet..
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I am not stating any of that. If skew could be arbed there would be no skew. The only skewed directional trade you should be interested in is a risk-reversal. Bull reversal and you win on Derman in the calls, and lose on the skew figure in the puts, but WTF cares as the puts are trading away.

IOW the vol-line isn't relevant as the short puts trade-away.

Don't get hung up on trying to be right here. Nobody knows you and we all have to learn this shit eventually. The last thing on your mind on a directional trade should be your vol-edge.

destriero · May 24, 2021

I'm gonna leave it here as we've gone off the rails in Tony's thread.

daytonabeach83 · May 24, 2021

destriero said:
I am not stating any of that. If skew could be arbed there would be no skew. The only skewed directional trade you should be interested in is a risk-reversal. Bull reversal and you win on Derman in the calls, and lose on the skew figure in the puts, but WTF cares are the puts are trading away.

IOW the vol-line isn't relevant as the short puts trade-away.

Don't get hung up on trying to be right here. Nobody knows you and we all have to learn this shit eventually. The last thing on your mind on a directional trade should be your vol-edge.
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not trying to be right, i'm trying to learn.. that's why i keep asking questions and dropping examples to clarify.. not to debate the point with you, but to flesh out the details.. i appreciate you having the discussion with me..

i figured the inability to arbitrage the skew is why it still exists, for sure.. any edge that can be arbed away would've already been long before i got into this shit..

but to be clear, i'm NOT basing my directional bias off the skew.. that's - pardon my language - fucking retarded imo.. i'm forming a directional bias and using the skew to determine which strategy most efficiently expresses that bias.. i.e., using skew dynamics to enhance directionality, a la @MrMuppet

word, my apologies @tonyf didn't mean to hijack the thread haha

taowave · May 25, 2021

You literally lost me with this responce.you bring up the skew differential on the 30 Delta put vs 30 Delta call,and then state that selling the 30 Delta put outperforms buy writing the 30 Delta call due to skew. Simply put,no pun intended,you are saying it's better to sell the 30 Delta put (or 2.33 of them)vs the 70 Delta put due to skew edge???

Dee,NWD and Kevin already responded,so I will address your beliefs from a different perspective,I.e directional bets...

If direction is your gig,check out Orats and backtest your "beliefs"..
You will have to decide the parameters, I.e what strike to sell( delta/percent if spot), DTE,and if you care to roll and frequency. Run the simulation over your chosen time period,and compare the risk reward metrics to long the underlying.. I think you will have a different outlook after testing your belief system...

Im not sure how you think "skew" can make up for Delta in a runaway bull market like we have had the last decade plus..Help me out..

My question to you when you say selling puts out performs long the index,are you saying to sell the Delta equivalent of buying 100 shares ( 4 D 25 puts)as opposed to 1 put as a stock replacement??

If so,you are closer to the truth,but not without the obvious risk in a correction..

Regardless,as a directional trader,I would strongly encourage you to backtest what you have posted.Sorry TonyF

daytonabeach83 said:
@taowave

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..
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daytonabeach83 · May 25, 2021

taowave said:
You literally lost me with this responce.you bring up the skew differential on the 30 Delta put vs 30 Delta call,and then state that selling the 30 Delta put outperforms buy writing the 30 Delta call due to skew. Simply put,no pun intended,you are saying it's better to sell the 30 Delta put vs the 70 Delta put due to skew edge..

^^^no, no, not at all! lol not at all.. i'm saying you'd be better off to sell the 30D put instead of selling an equivalent strike CC, or selling a 60D put instead of the equivalent strike CC, IF there is put skew.. i am also saying that you get paid more per delta to take the risk on a 30D put versus a 30D call.. and selling a 30D put, yes, would give you a lower cost basis than a 30D buy-write.. so your average entry price would be lower.. of course, yes, i'd much rather sell a 30D put than a 70D put, cuz i prefer to sell extrinsic not intrinsic.. i misspoke earlier and i think that's what caused the confusion.. i'll just share the quote below of what i said when i clarified my thesis after des pointed out the miscommunication.. also, i'm talking about skew as it relates to puts vs calls, not high delta puts vs low delta puts.. situations where put-call parity is broken..

Im not sure how you think "skew" can make up for Delta in a runaway bull market like we have had the last decade plus..

^^^i don't.. not at all.. but if you're talking probabilities trading as a lone investor, you're talking a lifetime of trading.. and even in a bull market, some months are up, some are down, some are sideways, so it isn't like you're getting raped to the upside every single expiration.. and over a lifetime, yes, you'll underperform in raging bull markets, but you'll overperform in sideways/bear markets, and in the long run the difference adds up in your favor.. that's the thesis..

My question to you when you say selling puts out performs long the index,are you saying to sell the Delta equivalent of buying 100 shares ( 4 D 25 puts)as opposed to 1 put as a stock replacement...

If so,you are closer to the truth,but not without the obvious risk in a correction..

^^^no, that's not what i'm saying, and your final statement is exactly why i'm not saying that.. delta aside, a short put represents 100 shares notional risk on expiry.. i'm referring to selling OTM puts were the skew is elevated..
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this is the clarification on the point i was trying to make..

daytonabeach83 said:
you receive a larger credit per delta when selling the 35D put versus the 35D call, even tho your delta exposure is the same.. but also, yes, buy-writes at the same strike as a short put..

also, use IWM july 16 current contracts as an example:

if we're just talking credit-per-delta risk, the 34D put marks @ $5.18 and the 34D call marks at $3.84.. that's $0.15 per delta for the put and $0.11 per delta for the call.. obviously, short the put and long the call, yah, risk-reversal..

you said same strike will yield the same cost basis, but that's not what i'm finding right now, at least not here..

$223 strike buy-write vs a $223 short put.. IWM @ $221.40, $223 short call marks at $6.58, cost basis @ $214.82.. $223 short put marks at $8.57, cost basis on assignment @ $214.25.. the short put reduces cost basis per the amount of skew.. small difference, obviously, but it's there..

the point i'm trying to make in this thread is that shorting puts where there is put skew is going to give a cost edge over buy-writes..
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taowave · May 25, 2021

I'm way too lazy and way too tired to read everything,but did you account for the June dividend,assuming there is one??
Looks like a quarterly div is coming up,and it's about the same size as your "skew edge"...

daytonabeach83 said:
same strike call and put do not always trade at the same vol? that's the whole idea behind vol skew, that put-call IV isn't always at parity..

IWM, July 16th:

$223 strike buy-write vs a $223 short put

IWM closed @ $221.40 according to ToS

$223 short call marks at $6.58, cost basis @ $214.82

$223 short put marks at $8.57, cost basis on assignment @ $214.25

the short put reduces cost basis per the amount of skew.. small difference, obviously, but it's there..
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daytonabeach83 · May 25, 2021

taowave said:
I'm way too lazy and way too tired to read everything,but did you account for the June dividend,assuming there is one??
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in the case of the $223 put vs buy-write, the dividend payment (est. $0.392) would offset it but only by maybe 60% or so, and that's assuming the stock moves don't wash it out..

it's pretty close to the same amount as the projected July carry fees, so it would offset the ATM synthetic long @ $222-223..

but on any other directional trade i've looked at setting up, no, the dividend isn't nearly enough to account for the pricing discrepancy/positive expectancy in the trade.

taowave · May 25, 2021

Including div,conversion looks in line to me,give or take pennies..

daytonabeach83 said:
in the case of the $223 put vs buy-write, the dividend payment (est. $0.392) would offset it but only by maybe 60% or so, and that's assuming the stock moves don't wash it out..

it's pretty close to the same amount as the projected July carry fees, so it would offset the ATM synthetic long @ $222-223..

but on any other directional trade i've looked at setting up, no, the dividend isn't nearly enough to account for the pricing discrepancy/positive expectancy in the trade.
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