I think the reason most people blow up selling options is the same reason most people blow only buying options, and that is, they don't know how to trade options. I know it's a simple answer but it's the truth.
Couldn't be better said, Maverick. It's really amusing when someone proposes selling premium as a viable strategy and 100 people who don't belong anywhere near an option come out of the woodwork telling the person not to do it because they've been listening to people without a clue telling them to never be short premium. Selling premium is a perfectly viable strategy if you're smart about it. There is a right time and place for every trade and the same applies to being short gamma. When I first started trading options I was making a phenomenal (to the tune of 20-30% a month) return being a net seller of premium. Then in one month I almost blew out my entire account. I had a biotech stock I was short gamma on gap down 14 points on the opening on a bad FDA decision. Another stock, similarly short gamma on, got a buyout offer and gapped up 8 points. Another stock gapped 7 on some other piece of mind-boggling news all in what should have been a rather tranquil July month for me. Murphy's Law struck true to tune and everything that could go wrong, did. To make matters worse, the entire market was volatile that month and stocks I was short gamma on that had no stock-specific news ended up being huge losers because they moved big and I wasn't hedging them at all. Even with the FDA decision, buyout offer, etc. it still could have been a decent month had I not lost big (and stupidly) on stocks that had no alpha risk type events but just ended up being sympathetic to a market much more volatile than I had expected. I sat down and really took the time to figure out what the hell I was doing and made a comeback because I learned one simple maxim that has allowed me to trade successfully since then: Pray for the best, hedge for the rest. Shorting gamma is a fine core strategy as long as you know how to hedge and do it vigorously. Ik
Mav, you and Ikspec nailed it. The worst hits I've taken in my career trading options have less to do with options-specific mistakes and almost everything to do with simple bad trading. In particular, though I've made more than a few options related errors, especially in my first year or two trading them, my biggest drawdowns resulted from a lack of discipline, poor risk management, insufficient trade planning and bad position sizing/money management. That plus a couple instances of regrettable "revenge" trading. In other words, the same kinds of things that get stock and futures traders in trouble. Thus, while I agree that selling naked options in certain circumstances is a bad idea (i.e. on low IV/high real vol names), if one has developed the fundamental trading skills referred to above, it can have it's place under more amenable conditions. But without those basic skills, options, from the short or the long side, can be a very dangerous trading vehicle. Then again, so too can stocks and futures.
Merryl Flynch advised my buddies to sell naked out of the money IBM puts claiming it was as good as "found money" so my buddies did...sold them by the truck load. I remember them crowing about how much they were gonna make... When was this you ask? August 1987