Of course there is no advantage in edge. The advantage is in hedging. Faaaar easier to hedge with zero gamma then with gamma blowing up in your face. FACT!
I guess this is really another manifestation of the implied "Fed put"...Heck, there is a famous fund manager (not going to name name's) that has had, ummm "difficulties" on three (maybe more) occasions doing this exact trade...Years of market experience, tons of mathematical ability and yet it's bitten him multiple times...It really is never a matter of if, but when with this style...The addiction must be intense.
The only practical exit strategy is to take both ATM and OTM short positions to expiry - for maximum loss or gain. The line between loss and profit is very narrow and that line can be crossed back and forth a few times. Exiting early can leave money on the table.
Without setting a maximum loss criteria, you could incur insurmountable losses during large selloffs.
ATM gamma is far greater than OTM gamma, so would mind clarifying what you mean by the zero gamma comment? Thanks in advance, my friend.
Oh I see, you're referring to a spread. I was referring to a naked position without a long strike. Even so, if you profit 8 out of 10 times with an average profit of $1 and lose 2 out of 10 times with an average loss of $4, you break even. So let's say you have a slight edge in forecasting the probability distribution curve and create a positive expected value in your trades, a large single loss without a strict exit could erase your profits and then some.
Sure, if the market goes down 100 pts, your ATM position will have little to no gamma, your deep puts will have huge gamma. You "want" to sell peak gamma. That means any move away from your strikes "lowers" gamma". When you sell gamma away then you start off with little gamma and then have it explode in your face when the shit hits the fan.
I appreciate what you are saying, there is some good discussion here. FYI I've never been to a seminar and none of the books I read recommended any trading strategy (they were all just straight options info). I do understand the math though I am expressing it in more basic terms. We don't disagree on any fundamentals. There is absolutely different levels of accuracy in the forecast. It's not just price up vs price down. You have to be more accurate in your forecast with ATM than DOTM. I think that's pretty self explanatory as it's much easier to forecast within 1 month SP will not drop below say 1850, than for you to say it will stay above 2020. So yes, a forecast of prices can have different accuracy, and you certainly need more accuracy to make money with ATM put. As you said, that is option basics and as OptionGuru pointed out that's why the ATM put sells for a lot more. Yes there is such a thing as theta working for you. The higher Theta in your position, the more profitable your position will become each day if market does not move against it (i.e flat or rebounding in the case of our puts). In the ATM scenario, Theta is next to nothing once the put goes ITM. In the OTM scenario, if the market moves against you, the theta increases. Now obviously if you hold to expiry the ITM theta will jump in the last week or so. But let's assume we don't hold to expiry (which I basically never do and maybe that's why we have such different views), then the position with OTM puts recovers even if the market does not. The ATM position now ITM needs the market to go all the way back up to BE. It would be helpful if you can explain how far ITM your ATM put goes before you close it at a loss? And do you open a new one at that point to make up for that lost premium? I understand if you don't want to share your specific strategy, but if you do it would be good to compare this in some of the scenarios from 2015 and 2008 to see how ATM vs OTM would have fared. I would really love to prove to myself that ATM is better. I trade full time professionally so I don't care if it takes 1hr a day or 6.5hrs to manage it.... Appreciate the discussion...
Let me put it another way since some of you are overly focused so much on the discussion of ATM gamma and OTM gamma. Forget the math and just look at it in a bigger picture using ES: If you sell the ATM straddle short for 100.00 and the market drops (ES) 80 points the put is driving up in value yes but the call is losing a ton of value so although the two do not cancel each other out perfectly, the call gain offsets a lot of put loss not taking into account vol changes. So the ATM straddle will not explode against you if the market drops 80 points (outside of vols) because one side of it is losing a ton. it could move against you sure but you take small loss if you choose to exit or roll or whatever. If you sell the OTM put alone and the market drops 80 puts, that entire spread is exploding against you in a huge way (i.e. you sell if for 2.50 and it could pop to 20.00). It is all against you. it goes from tiny delta and tiny gamma to much bigger delta as gamma gears up. The ATM straddle can be tested in Analyzer by moving the current price and you will see that a 100.00 straddle might pop to 110 on a market plunge due to put surge and calls not losing all value with IV increase. However that loss is more than offset by the regular "wins" versus the short put losses v. short put wins which could be huge net deficit. I am not advocating one over the other, just getting you to see it a different way rather than let gamma confuse the big picture.