index option naked put hedging strategies

[jinget]

Hey everyone, I was just curious about what some of you do to protect yourself against large drops in price when you have sold naked puts?

 

[Martinghoul]

You got to ask yourself one question... What precisely is the point of selling naked puts if you feel that you need to protect yourself against large drops in price?

So my answer to your question is this (pls forgive my levity):
"to protect myself against large drops in price when I have sold naked puts I sell fewer (or none at all) naked puts"

 

[jinget]

I just read another thread I found on the subject ( I guess I should have search a little better first) that you responded to suggesting to buy a deeper OTM put to turn the trade into a spread and this could work.

The point of selling naked puts is to bring in income every month. I am selling pretty far OTM so the only things I would be concerned about would be things like a Black Monday or Flash crashes and I am not selling enough of them that I run out of margin room.

I was just curious if anyone had some good strategies I have not thought of yet. Even if I were to do a spread trade and the index dropped 10-20% in a Black Monday type event, I would still loose all my capital if had sold as many spreads as my margin allowed, but I guess at least I wouldn't loose more than that by being naked.

 

[Martinghoul]

Dude, my honest advice is this: if you're afraid of the drawdowns, don't sell naked options. Whatever "clever" stuff you try to do to mitigate your losses will simply eat away whatever income you're generating every month, especially if it's from selling far OTM options. In general, I, personally, think that selling far OTM options is a terrible idea in an overwhelming majority of cases. I sincerely hope you stop doing it before you experience the pain. At any rate, as you mention, you have seen my older post on the subject, where I mention this already.

 

[HowardCohodas]

I frequently trade naked, but I never do naked trades.

 

[jinget]

What strategy would suggest in lieu or selling naked options?

 

[Martinghoul]

All depends on what you're trying to achieve... Whatever you do, it's a matter of doing some work, rather than a simple recipe.

 

[jinget]

I am prepared to do the work and basically what I want to achieve is progressively larger monthly income from options sales, I don't care if I do it with spreads or naked as long as I am making money.

 

[HowardCohodas]

I am prepared to do the work and basically what I want to achieve is progressively larger monthly income from options sales, I don't care if I do it with spreads or naked as long as I am making money.

At the moment, the only strategy I have in play is index options credit spreads that go on to form iron condors when the market conditions permit.

If you have questions, ask away.

 

[jinget]

From quickly glancing at the SPY and OEX index options, it seems that if you are working with weeklys you can only go about 3% out of the money to still get a credit (assuming you are just buying the ask and selling the bid) and if you go to a monthly you can go about 6% out of the money to get a credit. It seems like it would be pretty easy to get stopped out if you were wrong on your directional call of the index, but the limited losses are a nice feature.

How close to the money do you usually place your spreads? Do you have a preferred index to trade? What do you usually use as a stop out point?

Thanks

 

[jontyxxxx]

Hi Jinget - I followed a strategy like yours and asked a similar question on this board. I have to say Martinghoul has some very good advice. I was very gung-ho, made super profits and then realised (I watched the flash crash in May 2010 which was sobering - 1,000 points drop in 10 minutes - fancy losing everything you have worked for? Just takes North Korea to go crazy..........) that there are unexpected events you cannot factor in (read Taleb!). Better lower profits over a longer period! Having said this I have still made plenty of money but I have significantly reduced monthly earnings and risk. There are uncertainties you dont know and being on the wrong end of puts can be disastrous!

John

John

 

[tommog]

A few things to try, but most people that play this sort of options writing income approach is to buy slightly further out of the money puts to hedge yourself if the price blows through, so sell 4000 put for 20. Buy 3500 put for 10. You have reduce your max profit from 20 ticks to 10 but your downside is capped

 

[Hoggums]

A few things to try, but most people that play this sort of options writing income approach is to buy slightly further out of the money puts to hedge yourself if the price blows through, so sell 4000 put for 20. Buy 3500 put for 10. You have reduce your max profit from 20 ticks to 10 but your downside is capped

Downside is capped at 490 points vs 10 points profit max.

Terrible terrible win/lose ratio.

 

[tommog]

Hoggums,

Was simply explaining that by buying a further out of the money put you are limiting your losses. Is up to the trader to decide where to buy it

 

[kinney]

Despite the previous posts, I have found selling and hedging naked puts to be a useful investment strategy. The skill and the work is in choosing the correct strikes to sell and an appropriate way to hedge the puts. I would not dismiss naked puts out of hand because of market crash scenarios, after all investment is always about calculating a suitable risk reward ratio, if you can't stand the heat......

 

[jinget]

Wow haven't been on this forum in a while. I have continued selling naked puts and the occasional credit spread if I don't want to use much margin. I developed my rules overtime that have served me well. I now seem to stay away from speculative stocks and stick with the large cap dividend payers that will be around for a long time, that way if there is a big drop I am not all that concerned. I can average down, sell calls, roll, etc... I know much more than I did when I originally posted my question.

 

[A Dashing Blade]

. . . what some of you do to protect yourself against large drops in price when you have sold naked puts?

1) Have change of underwear handy
2) Have sympathetic bank manager willing to lend you several times your initial stake to meet your margin call
3) Declare yourself bankrupt

(Serious)

Bottom line . . . you can't

 

[Mike boschert]

Never sell naked, the pros don't doit and neither should anyone else. Do a study on ltcm and how the masters of the options world about took out the whole market selling naked. If Nobel laurietes who designed the black scholes Merton model go broke so will you. Check out Niederhofers blow up. Give up some potential for profit by getting hedged

 

[Taibucko]

Really this is a far more important topic than these posts have given me thus far. Possibly I have jumped into the middle of what started out as a more considered topic. Where can I get more information on hedging naked option selling?

 

[Taibucko]

Do any of you use futures contracts.