Vertical Spread Vs. Naked Put

Discussion in 'Options' started by Spaghetti Code, Jan 12, 2021.

  1. I think the S&P 500 will not drop by more than 10% By February 19th, 2021. $SPY at close was $378.77. 90% of this is $340.89.

    There are three ways I consider trading this:

    1. Sell a Put vertical spread at 340 to 335, currently at $4.68. Max profit: $32, Collateral: $500.
    2. Sell a Naked Put at 278. Currently $0.32, Margin Required: $2,812.
    3. Sell a Naked Put at 340. Currently $2.05, Margin Required: $3,888.60

    Suppose I have $12,000 I would like to invest:

    1. Sell 24 spreads, for a max profit of $32*24 = $768.
    2. Sell 4 contracts ($2812 * 4 < $12,000), for a max profit of $128.
    3. Sell 3 contracts (3,888.60 * 3 < 12,000) for a max profit of $615.

    My question is : why would anyone sell naked, when the margin requirements are so high? It seems like you would never be able to deploy your capital if you had conviction about where the price was going. Choice 2 is enormously safer than Choice 1, but has the same payoff if correct. Choice 3 is At the same strike as the short leg in 1, but still cannot return as much. Why do people suggest trading naked? The super safe choice has terrible return. The super risky one has worse return than the spread.
    caroy and BMK like this.
  2. caroy


    Another thought is to trade the /ES futures. Span margin on futures is not as capital intensive as the margin required to short the SPY. Depending on what you want to do it can be more capital efficient to trade the futures. For the same $12,000 in margin you could sell 2 of the ES 3400 puts and collect $1,875 in premium. If you used the spread and do 24 in the ES futures you're collecting $3,780 in premium. Granted SPAN margins are going to change as the underlying moves but the return on your capital is going to be better.
    Spaghetti Code likes this.
  3. JSOP


    That's because you are selling larger amount of verticals than naked. If you sell just 4 or 3 verticals like how you sell the naked, the profit from the verticals is lot smaller than the naked. That's why ppl sell naked rather than the safer verticals. I don't agree with selling naked because of the potential unlimited losses but that's the reason why. It's profit potential in case if you make it. It's $$ in the banks.
    systematictrader likes this.
  4. FYI

    Naked Put = Covered Call
    cesfx likes this.
  5. .sigma


    Sell a put, wuss
    stochastix likes this.
  6. That's a good idea. I hadn't considered before, but now I recall hearing someone say the assignment in /ES isn't as bad as the ETF assignment. Going a little further: why not sell defined risk on /ES?

    Right, but I would be amazed if people tried to risk management based on a number-of-shares basis. It feels like some traders are looking purely for a high chance of profit, rather than just a high profit.

    Acknowledged, but covered calls aren't for me. I don't like having to mind the dividends, and I don't like holding a large equity position. Covered calls are much bigger BP reduction.

    Help me find the one that pays the most.
    .sigma likes this.
  7. JSOP


    Be a wuss and don't sell naked options even puts because this could happen to you:

    The guy went from a comfortably retired civil servant to being bankrupt with $500K+ debt and multiple lawsuits overnight. He basically went to bed all nice and comfy with all the money in the bank on Sunday and bankrupt when he woke up on Monday, the day after. All the money that he worked and saved for his ENTIRE LIFE, every single penny of it GONE and replaced with debt that he could never repay because he was all retired. Mind you this was in 1987 when the value of SPX was in the hundreds. The SPX dropped 20+% over the weekend from basically one day to another. Imagine what would happen if this happened today. Sure today circuit breakers which was implemented because of this crash would kick in at 7% like it did on March 9 and March 12 of last year during the 1st wave of the pandemic but you would've already lost 7% from just ONE day and assuming that it won't drop any further once the market re-opens cuz the circuit breaker at 1st level is only for 15 min.

    So is it worth it? It's up to you to decide.
    Last edited: Jan 13, 2021
    stochastix, Option_Attack and caroy like this.
  8. caroy


    There's no risk of early assignment and most of the financial futures are cash settled unlike the grains and softs. Yes on the defined risk. I partook in a small fund once that sold out of the money spreads based on the MACD and Moving average cross showing a reversal in trend. They would sell the spreads collecting premium and made the argument SPAN margin made it more doable and profitable and they knew max risk at entry from a risk management position anyway. But there is a warning is that exchanges can I believe at their discretion raise and lower initial and maintenance margins which mid game could then effect SPAN margin. I defer to those wiser on this front than I am but if you play around in your account with order entries in SPY vs ES you can see what I'm getting at.
    systematictrader likes this.
  9. Yeah, the thing about selling naked is that you really can't (reasonably) model possible losses. Sure, it can only go to zero (if NPs). But zero can be wayyy down there. Especially with indices. $300 to almost $12,000. Ouch.

    ...Around Oct. 1, when the S&P 100 index was about 320, a put to sell the index for 305 was trading in the 3-to-5 range -- $300 to $500 for a standard option on 100 shares. By Black Monday, two weeks later, the S&P 305 put was worth $11,800, and investors who sold them for $300 to $500 had to make up the difference.
    JSOP likes this.
  10. stochastix


    if you are worried about crash buy VIX calls which will pay
    #10     Jan 13, 2021