<<< I think I understand the risk in this a bit better now. However those premiums are awfully alluring! Options simply seem like an insurance company in the equity market. >>> If you are selling a put, then YOU are the insurance agent selling stock insurance. YOU are protecting other peoples stock from a potential big drop. Hence the reason YOU must buy a stock trading at $15, at a price higher than $15, if that stock dropped below your insured price of 16 - 30 or whatever price you insured it against. Hence the reason you should NOT sell puts, if you don't have an understanding of what a good price value for that stock is.... both technically and fundamentally. It's NOT a game. It's a very risky business. If a stock is trading at $30, the lower the price you insure it against dropping below, the less money you will receive for the deal, but the higher the probability for success. So first decide what is the minimally acceptable annualized % return you would be satisfied earning on a deal, and then select strikes as deep OTM as you can to earn that % return. For some traders that may be 10%. For others 20%. For others 30%. Don't worry about what others are earning. Decide what is YOUR minimally acceptable % return. Just remember, the higher your % goal, the less probability you will achieve it. The lower your % goal, the higher the probability you will achieve it.
Well yes, but he also has to understand value for price: is the iv of the option - which is how the option is going to be priced in relation to the time left to expiry - high in relation to historical vol? Is the reason for that a good one or a bad one? That's a judgment call, and a tough one. But it's also vital, because as a seller your principle risk is a spike in vol. Doubly so if what you're selling is puts, since vol tends to rise as price declines, as we all know. The single best thing to do when you're starting out is simply to download off of Yahoo or Google the price history of the stock or index, then figure out the actual realized vol, annualized, in the past for what it is you're looking at, and do that for lots of different timeframes. That at least gives you a benchmark from which to measure the current iv of the options on the underlying. It's a very simple exercise, trivial almost, but very useful.
<<< Well yes, but he also has to understand value for price: is the iv of the option - which is how the option is going to be priced in relation to the time left to expiry - high in relation to historical vol? >>> I agree IV is an important consideration. But not more important than strike price selection. A slightly higher IV may get you a higher dollar profit, but it would need to be sig higher to offer you a lower and safer strike selection. The problem I have with relying on "historical IV" to select when to pull the trigger on a deal is, it's unlikely you will know the "context" of what was going on with the market, your stock, and the sector your stock was in, at the time the IV was hgh, low or midium. Are you really going to review the news of that period, that influenced the market, the stock and the sector it was in? What good is historical IV, if it lacks "context" with which to interpret it? If a deal offers the strike you desire, a credit you are satisfied with, a dollar and % earned that is acceptable, for a contractual unit of time you are comfortable with,..... don't wait around for a fantasy higher IV that may not show up. And if it does come, if you waited too long for it, you may end up losing it to time decay anyway. I agree a spike in IV is a negative if it occurs after the trade is initiated. But mostly only if you hoped to buy back the put and close the trade early. While closing a trade early for a profit is a treat I look foward to, it is NOT my primary objective. My primary objective is selecting the right strike price, per unit of time. If I can get the credit I desire, to earn the dollar and % return i desire, the deal get initiated.... regardless of whether the current IV is lower than it's historical norm. Really makes no difference to me, if I'm earning my 16% annualized return on stock "A", with it's higher than average IV, or stock "B" with it's lower than average IV. All things being equal, I'm going with the one that meets my criteria for tech support, fundamental health and price value.
I was simply pointing it out as a benchmark. Not knowing what the normal vol is of the thing you're looking to make money on if you're playing with options is not really a good idea. It's simply the foundation on which you build your case for doing whatever it is you want to do. Different stocks have different normal vol levels, and of course what's normal varies over time, especially if you're looking at a stock that starts to pay a dividend or starts to pay a much higher dividend than it used to. Also, it's a good idea to figure out the direction of volatility: commodity companies tend to have a much flatter vol distribution between puts and calls, that is, calls aren't too much lower than puts, because their price is partially based on the commodity, and commodity vols are also much more even in terms of puts versus calls. Studying what's normal for vol in different stocks and different types of stocks is fundamental to trading options. Saying otherwise will mislead those who are new to the game.
<<< I was simply pointing it out as a benchmark. Not knowing what the normal vol is of the thing you're looking to make money on if you're playing with options is not really a good idea. It's simply the foundation on which you build your case for doing whatever it is you want to do. >>> I view historical IV as... "a tool". Strike price selection, credit, % return, dollars earned, % otm safety cushion, tech support, unit of time, and so on are also tools. I agree that the more tools, criteria and benchmarks one evaluates for a trade the better. I just don't place as much value on historical IV as many traders do. I see it as just one of many critieria to perhaps consider. But i don't let it overly influence my trading, if at all. For others it's way up there on their list of importance. We each have own critieria we evaluate in terms of importance. If i want a deal that is 15% otm for safety, and the deal only offers 8% otm, for the strike and credit I desire, chances are the IV is too low to accomplish what i want. I really don't need to know it's IV is low relative to it's historical average. I only need to know that I'll be looking for a trade elsewhere. And if I did know the IV was low releative to it's historic past, I'd still be looking for another trade. But what if the IV was low, but the trade allowed for the 15% otm cushion I wanted. Should I not do the trade? Obviously I'd still do the trade. So my point is, while historical IV is a tool some may find useful, for me I rank it's usefulness low on the scale. Others swear by it. Perhaps most others. Obviously higher is better, but I'm not waiting around HOPING it rises, before i initiate a trade that meets my overall criteria. I think the IV that investors should focus on, is the one pre and post earnings. But I agree it is a tool that investors should be aware of.
It's a very dangerous strategy if you let yourself get sucked into collecting premium and fail to carefully calculate your complete risk profile if the market tanks under you. The strategy, when not handled carefully, has been the ruin of many a trader. And I speak from painful experience. Sell only cash secured puts and only on stocks that you are completely comfortable owning. And realize that with volatility at such a low level at present, you have the added risk that an explosion in VIX can quickly put you in a deep hurt. Best to put your ideas aside for now and revisit them when VIX jumps and there is blood in the streets.
Ok, got it. It appears that for selling puts to be long term +ev, you need to know how to properly value a company? Simply sitting back and thinking you can collect the premiums is not wise if you do not understand valuations. Think I was putting the cart before the horse before. thanks all
Selling puts still has less risk than outright shares. That being said, all trades have a total annihilation risk in them. If managed properly selling puts can be a good strategy. If you get put, write calls against the shares. I know at least two people who do this successfully, but they never overleverage, and always have cash at hand in case shit hits the fan. Just dont allocate 100% of your portfolio to selling puts on one stock. Apply some risk management, diversify and mix with some common sense, and you'll be fine.