Selling options in a world of flash crashes

Discussion in 'Options' started by short&naked, Mar 12, 2013.

  1. I would like some information on how option premium writers handel a liquidity crunch during a flash crash or general crash.

    The main argument aginst HFT is that liquidity is pulled just at the time when it is needed. During the May 2010 flash crash, this seemed to have been an issue even with SPY and ES, with the exodous of market makers reducing liquidity and increasding spreads. I imagine that liquidity drying up would be an even greater problem with an already less liquid option market.
  2. If you are selling premium on stock you are not willing to potentially buy and hold during the crash, you will probably not survive the crash.
    Liquidity will dry up,... the spike in VIX and IV will result in a spike in premium, thus making it VERY expensive to buy the contracts back and close the trade,... the bid/ask gap will suddenly become HUGE, making it even more costly to close the trade.

    If you can buy and hold, you can collect dividends and sell covered calls below your original strike, while you wait for recovery.
    On the other hand, if you used excessive amounts of margin leverage to initiate your contracts, then you will probably not survive the crash, as you can NOT then buy and hold.

    Your best bet to survive a crash selling premium like puts is,....
    Don't invest in over valued companies, as those prices may not be recoverable.
    Don't invest in over debted companies, as that excessive debt may make the company unrecoverable.
    Don't over concentrate in one stock or sector.
    Diversify among many stocks and sectors.
    Don't over concentrate your trades into just one month. Layer them over a number of months.
    Don't invest using excessive leverage.
    Reasonable leverage is ok, and your covered calls and dividends will reduce your daily costs.
    Consider buying protective puts on your more volatile companies.
    Select stocks and prices that show long term tech support under your strike. The more times the L-T chart shows successsfully tested support in that area, the better.
    The best way to survive a crash, is to prepare for one BEFORE it occurs.
  3. Trader13


    Basic risk management ... you need to have a hedge in place when you open your position.

    Something as simple as a short vertical spread is a quasi-hedge for black swan events since your loss is defined and limited to the difference between the strikes.

    Or you can open an intermarket spread with a correlated instrument. But you may not get any margin relief as your broker will consider your short position uncovered. And in this case, your loss is undefined and limited because you can't know precisely how the correlation and option pricing will react for both instruments under market stress. But your expectation is that you will realize some degree of protection to avoid a catastrophic loss, and in the best case, breakeven or a small profit if the idiosyncratic price movements of the two correlated instruments works in your favor.
  4. +1
    buying deep otm options to cover naked positions gets you away from the variation in margin requirements..
  5. I agree that stability in margin requirements is a reasonable goal.
    But only if that margin requirement stability, doesn't come at the price of now being on excessive margin leverage.

    Lack of stability is only a big deal, if you are on excessive leverage to begin with.
    As that margin requirement volatility, can result in an unexpected margin call, on stocks and prices you are not in a position to consider buying.