Right. What you do equals covered call writing (selling the call and buying the stock) and that clearly is less risky than just buying the stock. If you do it with very far OTM puts, it almost equals buying T-bills (collecting the "risk free rate"). That is just put-call-parity, the most fundamental equation in option pricing. The tradeoff is that your gain is capped at the premium in bull markets, your alpha is not near 30% a year, it is much lower.
@robertSt as a hypothetical sample, what would you do if you sell put at say 30 strike and all of a sudden the next day stock gaps down to 15?
If the put still has time value, I'll keep it until it erodes. Then I would roll it down as far as needed to pick up more time value. This scenario would likely result in a loss. But you still have options, you could take assignment if you liked the stock and write calls. My strategy doesn't prevent losses, especially for catastrophic or black swan events such as you hypothesize. But it does mitigate the damage. If you are diversifying, you will make enough on the other positions to not suffer too much from the occasional large loss.
your strategy should be fine until a stock makes beyond a two standard deviation move. At that point you will become an investor holding a stock with big losses or your down and out rollout could be 9 maybe 12 months out if not more depending on how quickly the stock moved. You mentioned WLL. That stock dropped a lot. How did that work out for you?
Not quite, he already owns the stock if he sells puts without leverage. That is equvalent to covered call writing (stock long + call short, put call parity). Compared to buy and hold, selling puts is less risky in bear markets (because of the additional premium from the call). The offset is that it is less profitable in bull markets. So I wonder more about his 30% yearly last 3 years. Must have been very high IV stocks (meaning they dipped before he sells puts?).
Thank you for elaboration. Don't you consider adding a far OTM cheap long put leg to your plays to hedge from black swan events or it's not worth it?
When you sell a put you take on the obligation to buy stock at the strike price. You don’t actually own it till it is assigned. Leverage has nothing to do with that but it can amplify the potential losses. The end result is that you start to inventory stock with losses. Which you want to square up with wins at the end of year. Hopefully you have more wins than losses.
That is not what I said. Again, selling puts is equivalent to covered call writing. That is "put call parity" the most basic option pricing principle, it is in every option book. If he sells a put, he can think of it as a virtual stock long and a virtual call short (it is the same in the absence of dividends or generally cost of carry).
if you have a Move like that there is not much you can do. Buy the put back for a loss or assume the stock and sell covered calls but most likely at that point a move like that is so destructive and final that you are best moving on and taking the loss. If you have diversified and managed position size well, it will be just a minor hick up or speed bump on the road. Rolling down and out puts won’t cover the loss in this example.
I am an options trader with moderate experience, far less than many on here. I have both bought and sold options and, of course, have experienced both wins and losses with these strategies. I have not backtested anything but I have to say that I believe that selling premium is the better way to go. The time I may disagree with that is if you are a rank beginner, where buying options may be the way to go due to the defined risk. It is my opinion that if someone has not mastered the mechanics of managing a trade or the emotions that come with dealing with a trade going against you (more likely with a beginner), than the defined risk of buying an option is better. For the more experienced options trader, I feel that selling premium is the way to go, for many of the reasons stated previously. If I like a stock, I may sell a put on it to get it at a better price. If I don't get it, I have at least received a premium. The trade can go against me a bit if I am out of the money and I can still win. If I am assigned and the stock continues to go down, how is that any riskier than if I had bought the stock outright? If I am selling a put on a stock, I choose one with a good dividend so if I am assigned and the stock goes down, at least I am receiving something. If I buy a call and the underlying goes nowhere I lose money, being subject to time decay. If I am a beginner, it is a way to learn without much risk. I would invest only a small amount in this strategy. If I sell a put, I can win even if it goes against me but I must learn the mechanics of how to manage a losing trade. No one should be selling premium without understanding this. It used to scare me (it still does a bit but I am more experienced now) and it is important to thoroughly review an exit strategy before a trade is made. Feeling bullish: sell puts or do credit put spreads on a major ETF. Feeling bearish: sell credit call spreads on a major ETF. Feeling neutral: sell covered calls on a stock or ETF that you own. I never advocate selling naked calls. I do call spreads a few days out on the major ETFs. I put a stop on these to cap my loss. In summary, I think selling premium is a better strategy for those with some experience and this can be done in any market.