The bottom line is that options writing takes every bit as much discipline as systematic trend following, mean reversion, scalping, etc, etc... It's true that the best performers, as a group, the past 36 months have been index options writers, but that also coincides with an implosion in implied vol. The survivors of this group have done well, but its also the kind of thing in which several months of accumulated profits can vanish pretty quickly and not because someone was unprepared of disorganized. It's just the reality of the way a security or an index can trade in a discontinuous manner. The additional factor that does not seem to be mentioned often enough is as follows: Index options have relatively wide spreads, can become illiquid instruments during period of high volatility and it's never that straightforward how to hedge them in a practical manner. Like anything else, they are a weapon in the hands of someone who has talent and a time bomb in the hands of someone who gets lax or underestimates the inherent difficulties of implementing strategies in ever changing market conditions and volatilities.
When will people understand that it makes no difference if you buy a 20 delta option or sell a 20 delta option, the expectancy is EXACTLY the same! I think some people on this thread need to re-read Natenburg a few times. Let me translate this into ET language. There is no edge in SELLING an option with the same delta over BUYING that same option.
You obviously do not understand a single thing about the greeks. Theta is not an edge. It's a function of volatility. Volatility is a function of delta. Delta is a function of price. The delta of any given option is priced very efficiently as to not favor the buyer or the seller. If what you are saying is true. One could trade synthetics to make millions. What you are saying is that selling a 20 delta option has some sort of implicit edge. That would mean one could sell any given option and buy it's synthetic counterpart for a risk free profit. Obviously if you understand put-to-call parity, you would know this is not possible.
I think what people are trying to say is that implieds are in general trading at some risk premium over the realized. What they forget is that there is a good reason for this risk premium. Traders who do not think of these things, would eventually realize it the painful way. Now, when someone says they are writing options for a hedge fund, I doubt they are just selling them naked. Most probably it involves some sort of short-gamma or short vega strategy (ratio spreads, calendars etc.). Some people take directional view, i.e. they trade risk reversals for a premium. For instance, I feel that because of political pressures on Fannie and Freddie, there will be no GSA demand for swaption vega any more. So my book is short vega, especially on the payer side. But I'd never base my entire strategy on selling naked options.
No Sle, what I think people are saying is that selling options has an edge over buying them. This is a very common misconception to those who do not understand the way options are priced. Many people believe, wrongly so, that there is an implicit edge in selling any given option over buying that option. This of course is mathematically impossible. The only way one can realize true theoretical edge in any given option is through conversions and reversals as it locks in any kind of pricing discrepancy. Albeit at the cost of pin risk. Now there are many people who sell options for the purpose of either speculating that back month implieds will drop in the future creating vega gains, or through a drop in *spot* volatility. However, one does not gain this edge by simply selling an option, but rather being correct on his/her assessment of future implied volty or spot vol. If he/she is wrong on the future of implied vol or spot vol, they will lose money. I cannot make this any simpler. Sle, I understand what you are saying, but I think you are not understanding what some of the previous posters are trying to imply.
Selling naked calls is suicide. Sell naked puts ONLY and use the following basic rules: (1) Sell puts ONLY on stocks you would want to own right now at their current price. For example, let's say you like Frontier Oil (FTO) right now at $27.95 (7/28/05). You can sell the August 25 puts for 0.45. You collect $45. Worst case scenario, you end up owning Frontier at a net cost of $24.55, a nice discount to the $27.95 current price. Could the bottom fall out? Sure. But the bottom could fall out if you paid $27.95, too. (2) Sell out of the money puts. (there are exceptions to this rule). (3) Sell near term expiration (40 days or less to expiration). (4) Screen for expensive puts (based on Implied Volatility), then eliminate the puts on stocks that violate rule #1. I use Optionetics Platinum for this. (5) Average 2% or more in terms of premium per share vs. strike price. In the above example on Frontier, I would probably enter a limit order for 0.50 (2% of the 25 strike price). Often you can collect 3x or 4x when IV is very high. Example: I collected 1.60 on a 30 strike this week. (LSCP Aug 30) That's better than a 5x. But be careful, very high IV can mean earnings announcement in a few days. I was short the Aug PUT on AFFX when it dropped $12/share this week on earnings announcement. Fortunately, I'd love to own some AFFX. (Rule #1) Rule #5 allows you to generate $2000+/month on a $100,000 account. If you're sticking with plays that have 90+ percent probability of going your way (Optionetics Platinum gives me this number), then you can expect to buy at least $10K of stock that month, and more likely $20K. Every few years you'll get caught in a market correction and buy lots more! Then you'll be very glad you've been sticking to Rule #1. I like companies with strong growth and low PEG, but I look at various other fundamentals as well such as profit margin, debt load, etc.
Okay, so now you've sold a put and it expired in the money, got exercised, and you now own shares of a company you pre-determined you'd like to have in your portfolio. What now? Get rid of them as soon and as profitably as possible. Sell covered calls against them every month until you get called out of your shares.