- Question about Volatility when selling premium?

Discussion in 'Options' started by Diceman34Mules, Jan 24, 2004.

  1. Hello,

    For all the experienced traders out there ...

    I just started trading options but have spent quite some time researching them. My intro strategy involves me selling front-month OTM premium to take advantage of the time decay. I'm using candlesticks and volume to line up my trades. Also, I won't touch anything unless it has an HV greater than 70 and an IV greater than that. My question is ... Am I missing out on plays that have, for example, an IV of 72 and an HV of 36 (extreme I know)? My fear is that I will just be setting myself up to get burned by the whole reversion to the mean principle. Any thoughts?

    Thanks in advance,
  2. While I'm all for positive theta, there are a couple things you should keep in mind if you decide to go forward with your plan. First, as I'm sure you know, volatility is at multi-year lows at the moment. That doesn't mean it won't go lower still. But it does mean that the risks from being short gamma are significantly greater and the rewards commensurately smaller than they were even a few short months ago.

    Second, though it's not ill-advised to compare SV and IV, what's more relevant is to determine how the current IV level of a stock/index compares with where its IV has been over some previous time period (i.e. 3 years). That's really the only way to determine whether the IV of a particular option is "high" and thus warranting consideration in a short vol position, or "low" and thus a more appropriate long vega candidate.

    Merely looking at absolute volatility levels, on the other hand, can be quite misleading. For example, which of the two would be considered to have high implied volatility: (a) ABC with an IV of 40 in the 99th percentile of its range; or (b) XYZ with an IV of 72 in the 22nd percentile of its range? (No answer necessary, as I trust the point is clear.)
  3. jeffgus


    The ability to collect premium decay is a good strategy, but always have some wings on the outside to cap the potential loss and and help hedge vol risk. Naked positions are ok 95 percent of the time , but the 5% will blow you out if the vol increases and an 87 or 98 panic would to hit. learn about haircut and risk margin. Butterflies and Condors that can be legged into will do the trick.
  4. My approach:

    1) Only sell index premium. Market-risk (e.g., 1987, 1998, 2001) is enough to bear without piling on firm-specific risk (e.g., Enron). Besides the market won't go all the way to zero -- or if it does we have much bigger worries than the size of our portfolios.

    2) Own ITM LEAPs to hedge the sales, especially in today's low IV environment. In some respects, this becomes a vega play. I lean the deltas on the LEAPs positive so that they counter-balance the positive vega (because price of the underlying and IV tend to be inversely coorelated).

    3) But, treat the sales as if they were naked and establish iron-clad bailout points. For example, if I sell an ATM straddle (say, on MNX) then I will buy back the puts or the calls if either by itself reaches the combined premium I collected. So if the puts and calls each sold for $4.00, I bail if/when either hits $8.00. This way I never have a losing month, but I do have plenty of months without wins.

    4) Keep 50% of the total investment amount in cash, at least at the beginnning of a trading month. This enables adjustments (e.g., buying wings) as the month wears on.

    5) Don't expect home runs. I expect an ROI in the 10-30% range, but I do expect it regardless of the underlying market trend. This strategy is designed in fact for a flat market. Other parts of my portfolio address bull and bear possibilities.

    You might want to have a look at "The Options Edge" by Gallacher in which he explores empiracally the edge of the options seller.

    Also, you might want to investigate Max Ansbacher's approach at:


    Good luck,

  5. lindq


    Listen carefully to the voice of experience. Do NOT sell naked just to collect a little premium, ESPECIALLY if you are new to options. A couple bad trades can kill months of struggle, and possibly your equity. You don't think it will happen, but it will. Why? Because shit happens, when you least expect it. And with the market near recent highs, and premies near recent lows, you are only adding even more risk for less reward.

    If you have the skills and intelligence to think you can even break even with short puts or calls, believe me, you will do much, much better at simply trading the underlying. And if you are not already very successful at predicting the movement of an underlying stock or index, then you will certainly not profit from selling options.
  6. Thank you for all of the responses. I do appreciate the feedback.

    I apologize for not relaying the fact that I am solely doing bull put and bear call spreads for the time being. I plan on doing calendars in the future but I am looking for a high turnover rate right now to aid my limited capital.

    I guess I'm asking whether I should filter out a list of potential plays based on volatility and then analyze the charts to see what makes sense or whether I can run my scans based on technical analysis first and then just make sure the volatility isn't extremely low.

    Thanks again.
  7. Maverick74


    Good post. I have nothing to add to that.
  8. It certainly is true that premiums are near lows, and possibly even true the market is toppy, however the VIX/VXO or premiums in general do not sky rocket over night (1-2 months). This process ROC of premium unfolds similarly to the underlying over time. I believe the blanket comments in regard to staying away from selling premium are the same relatively pompous arguments versus trading underlying assets in any discipline. Both general styles are dangerous for the uninformed.

    There is arguably no strategy more often correct than that of selling OTM options for the sake of income generation. The statement that it is a bad idea is not short of careless. There is no question that it is not for beginners, there is a lot to know you are correct: There is in fact a need to determine market direction; or lack thereof to some degree to be successful. There are far too many factors though, to state that it is plainly a bad idea. There are many that sell premium for a living and have done so consistently for years. Just as many make consistent cash day trading or swing trading. I would never choose personally to scalp for pennies and have maybe even less interest in investing. I perceive the risk, both mental and monetary, to be much higher for those strategies than that of a moderately aggressive options writer. And although I do firmly believe this, I will never assert there is no living to be made from such preferences other than my own.

    There is an importance in educating the novice, but to instill fear, I doubt is necessary unless we qualify it completely, by offering examples of why it cannot or never will work. Each trading style has their own merit and nuances, so instead of exhibiting our machismo possibly we can discuss both the benefits and pitfalls of such ideas?

    One does not have to lose their shirt selling premium, there are many forms of defense that can be implemented in case of the inevitable, as well as the ability to use stops just like most other trading forms. Care always needs to be taken, which ever type of trading vehicle you choose.

    It is a fact that statistically, options sellers even ATM, make more than buyers, so would your statements not simply be arguing that options trading is a bad idea in general? I doubt this was your intent....

    To add "wings" or to create a spread is not a bad idea inherently, but one must understand that the idea is the brainchild of the emotional need to feel protected. This logic may come from those who insist upon stating academically that there is unlimited risk in selling options. Don't get me wrong, this is in fact correct - technically, but once again; this instills unnecessary fear in the minds of prospective would be liquidity providers. Is there not unlimited risk in walking down a flight of stairs? I think i've made my point.... Wings provide a method of locking in ONLY a loss of one strike, while reducing potential profits at the same time. As a professional premium seller, it is extremely unlikely that I, and I am going to go out on a limb here, or any at all would consciously allow a naked option to go against them anywhere near a full strike ITM. My best analogy is that of imagining people wearing bicycle helmets to go for a walk.

    I just want to be clear that selling premium can be (even today) a viable and extremely attractive trading strategy, but just like any other, one MUST have defense in mind at all times; and be educated. One simply mustn't be blinded by the ~ 90%+ accuracy that sometimes incidentally results in lack of care when things DO go awry.

    Thanks for your time

  9. ktm




    Not sure where to start with that post. I don't disagree with any of it and really only have one question. Why bother?

    Are you looking for liquidity? As a fellow professional options seller, I need people to be buying - closing that spread and buying what I am selling. I have (on occassion) launched into the same kind of (driving a car is dangerous if you don't know what you're doing) argument on these boards about once a year, only to be given the same "lose your shirt" rhetoric from some who have sat idly while their ATM sales go DITM or otherwise failed to do anything sensible with their positions. Others see a nuclear holocaust as a good reason for not selling, which I certainly understand. I mean if we get nuked, the first thing I'm doing is checking to see what the VIX went up to, wouldn't you?

    Basically, this is a great gig. The vast majority here are not willing to put in the time and effort required to develop a workable, consistently profitable methodology sufficiently backtested to achieve high end returns. They want the holy grail for 49.95. There are so many ways to make a fortune in the markets, and I don't poo-poo on anyone's scalping, daytrading, arb'ing or whatever else they do to make a living. Selling broad based index premium is an outstanding way to make a living.

    I wouldn't work too hard to sell it to these guys if I were you. If they aren't receptive, that's less competition just inside the ask.
  10. I second the motion.
    #10     Jan 28, 2004