Selling Premium - Strategy Never Discussed

Discussion in 'Options' started by robertSt, Dec 4, 2018.

  1. robertSt


    I've been selling premium for about 3 years, and I have a data sample of a couple of thousand trades. My returns so far are between 25% and 35%, but I think I can improve going forward, since I have learned a few lessons and abandoned a few strategies that were not profitable.

    The conventional wisdom seems to be that premium sellers are collecting pennies in front of a steamroller, unwittingly setting themselves up for the inevitable catastrophic loss that will wipe them out. Rolling is usually dismissed as loss avoidance, but I have never seen anyone discuss the approach that I use.

    First, I sell weekly puts that are cash-covered. I never use leverage. I trade volatile stocks with high IV, so that I can collect between 1% and 3% per week. I typically sell fairly close to the money, often the next lowest strike, so many of my options move into the money. How do I deal with this?

    The key is that the options I trade must have enough premium so that I can roll down and out (usually one strike for one extra week) for a credit. If I can collect 10 to 30 cents additional premium, I can still have a substantial return when I'm finally low enough for the option to expire.

    If the put moves far enough into the money, I won't be able to roll with a credit. But in most cases, the debit is small enough to preserve most of the original premium collected. If the stock keeps moving down, I can do this for weeks, until I am back underneath it.

    Occasionally this strategy can result in being very far in the money. I have carried options that are 10 or 11 points in the money. In situations like that, it may not be possible to close the entire trade with a profit. But we all know that losses are a part of trading, right?

    The probabilities of being in a trade that goes against you that much are low. I am also susceptible to a black swan event. But I have much more flexibility with options than I would with a simple stock position, where I am locked into an absolute price point. With options, I can make adjustments, trading time value for intrinsic value all the way down, so that my loss will be half that or less of a simple stock position.

    Just interested to see if anyone else trades this way or has any comments.
    Rutalian85, Bum, ffs1001 and 7 others like this.
  2. smallfil


    Tried selling premiums with option spreads and still lost thousands doing so. Never understood the logic of trying to grab pennies while, risking dollars in doing so! The absurd claim is option sellers win 80% of the time and most options expire worthless. I think that is a lot of BS spread by option sellers. My win rate is 40% which means I lose 60% of the time. Since, I buy options, my risk is limited to the cost of the premium and my upside is unlimited the case of calls. Limited to zero in the case of puts. Also, most options buyers sell their positions way before it becomes worthless and keep the residual values for the next trade. So, where did the expire worthless BS come from? It is very rare my trades expire totally worthless and the options worth nothing at all. And if you don't hedge your positions and trade naked calls, good luck on that! It takes just one big whack to wipe you out like found out! Doesn't matter if you have $100 million in your account, you will lose it all!
    Adam777 and MKTrader like this.
  3. robertSt


    Well, the logic is that I'm making money. As I said, I don't use leverage. I typically have 5 or 6 positions a week, so even if Twitter or Roku go to zero, I won't be wiped out.

    The significant idea in my post is that you can roll down and out for a credit for most positions that go against you, placing yourself back out of the money.
    MACD likes this.
  4. Felix168


    In general the nature of options trading is to create a nice and smooth equity curve, until that one event strikes, that results in a sharp drawdown. Some math helps in understanding the chances of making money.

    When comparing VIX to historical volatility, you will find that in general VIX is higher, painting a darker than realistic picture of the future. VIX is calculated backwards through the Black-Scholes option pricing model, which should give you the arbitrage-free pricing for an option. The implication of VIX being too high is, that options are basically too expensive.

    Having established that, an option strategy selling premium has a good chance of making money, even if the algorithm has no predictive power at all, due to finding that future volatility is estimated too high... if you can deal with the sudden drawdowns.

    In order to see if a strategy has any legs, and how much of a drawdown to really expect, it is advised to model and backtest the algorithm. I have created an open-source backtester capable of simulating cash-settled, European-style options (e.g. SPX or XSP) to do so, you can find the project page here:

    robertSt, please reach out to me, if you'd be interested in modeling your strategy.

    Cheers, Felix
  5. robertSt


    I would like to add that there is a widespread misconception that selling premium entails some kind of wild risk that only a fool would undertake. I have made the case that selling puts is less risky than an equivalent stock position - it's just simple math really. The important thing is that I have the position cash-covered, I'm not leveraging with margin.

    A stock owner loses dollar for dollar with every drop in stock price. What do I, the put seller lose? Perhaps nothing. The time value I collected (the premium) may be enough to cover the drop in stock price while still returning me a profit.

    Let's say the premium doesn't cover it. The stock has dropped so far that it's 1 point under my strike, the time value is gone. So I trade the intrinsic value for time value by rolling. I buy back my put for 1.05 and sell one strike lower for next week for 1.20. I now have my original premium plus 15 cents. I have gotten paid to lower my entry point. The stock owner is where he always was. I'm now 50 cents lower with a large premium that is about to pay off, either this week or some weeks down the road, at which point I will have an even larger premium to collect.

    It should at least be clear that I have far more control over my position than a simple stock owner. And that means a lot less risk.
  6. lindq


    That is an easy case to make when, over the past 3 years, you've had the wind at your back.

    When the wind gets in your face, you'll find the sailing to be a lot rougher.
    Arnie Guitar, ET180, piezoe and 4 others like this.
  7. zdreg


    the traders and market makers on the floor don't trade unhedged. if they do they will soon be upstairs traders assuming they have capital left to trade.

    why should you?
    Last edited: Dec 4, 2018
    MKTrader likes this.
  8. smallfil


    Put options is different because your maximum is capped at zero. It cannot be more than that! However, naked calls has unlimited risk to the upside because you would be chasing to close your position by buying back the call option at way higher prices! If it runs, it can blow out your account. I would rather take a lower win trade but, with huge returns, multiples of my risk with my risk capped from the get go! If it works for you, good for you. There are multiple ways to make monies in the stockmarket as long as you practice some risk management. If not, one day, you will be wiped out! Only question is when?
  9. robertSt


    I've traded WLL since the October drop, from 56 to 28. I have traded a lot of stocks that have lost 20% to 45% of their value. I opened a Micron position at 60. It's now at 37. The lesson to me is that if my strategy is viable under these conditions, I have little to fear.
    PriceJuggler and Joe Chong like this.
  10. lindq


    Ha! The famous last words of busted traders now selling life insurance or cemetery plots.

    It has been my experience over the years that when authors, lecturers and amateur traders start promoting their put selling strategies, it is a sure sign that the bull market is officially over.
    #10     Dec 4, 2018