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Naked puts, options, lots to learn


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Naked puts, options, lots to learn

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 Big Mike 
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I have a lot to learn when it comes to options.

I was just reading this article and don't doubt that these scenarios exist, especially in this crazy market we're in today.

Serious Money: The world's dumbest market - BloggingStocks

Any one trading options care to explain some of this?

Mike

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 sam028 
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This kind of strategy exists, but this guy in wrong for few things.
When you sell a Put (we say writing a put), and at the same time you own the underlying (stocks here), this is not a Naked Put.
This is a Naked Put.
Theoptionsguide.com is, I think, the best website for understanding options, all the most commonly used strategies are there.
There is a lot of books on options, I like this one, for beginners, and then this one, which is really great (how to manage you positions).

In fact, I really love options, it's "slow", not like a crazy future contract, but it can be a very very powerful tools. I'm only playing with options spread, no naked stuff, I like to know, when I pull the trigger, what is my maximum drawdown.

I think every trader need to know, a least, what is an option, how do we play with it, and what are the basic strategies.

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 sefstrat 
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I'd recommend DeMark's book on trading options, it has a very good intro as well as more advanced techniques

That said, I've never personally traded options.. I only use options data to assist in trading decisions (also discussed somewhat in DeMarks book)

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 Delta_Panther 
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Does anyone use this kind of software for his option trading strategies ? :bmt-rocks:

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 sam028 
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You can have a look to Visual Options Analyser here, quite cheap. I use an Excel sheet, based on this one, with some "home made" modifications.

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 Delta_Panther 
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Thanks sam028

I will check it. OpVue 6 is quit expensive and I am looking around for some other ideas. I like to trade option on futures or with futures. I like to trade any kind of strategy. So I need to have an input mechanical or per hand on both products. I have to test that. In the mean time : Thank you and good trading for you and all the members.

Regards

DanPickUp

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 meyer99 
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sam028 View Post
This kind of strategy exists, but this guy in wrong for few things.
When you sell a Put (we say writing a put), and at the same time you own the underlying (stocks here), this is not a Naked Put.
This is a Naked Put.
Theoptionsguide.com is, I think, the best website for understanding options, all the most commonly used strategies are there.
There is a lot of books on options, I like this one, for beginners, and then this one, which is really great (how to manage you positions).

In fact, I really love options, it's "slow", not like a crazy future contract, but it can be a very very powerful tools. I'm only playing with options spread, no naked stuff, I like to know, when I pull the trigger, what is my maximum drawdown.

I think every trader need to know, a least, what is an option, how do we play with it, and what are the basic strategies.

Sam,
Are you still doing option spreads?
Can you show a little bit of what you do and rationale?
Any forums you recommend?
Thank you.

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 gio5959 
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when you guys think you have your options strategy figured out you should try doing binary options here - you can fund an account with as low as $100 and trade with as low as $30 per option trade - you just have to be right on your options for one hour (or less, depending when you get in) and you could collect as much as 81% of invested money - the downside is you could lose your investment - but what the heck we know the odds about trading , dont we

Binary Options Trading Broker | Winoptions.com

btw, tell them i sent you so i can get some bonus $ for referring you

gl

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 sam028 
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meyer99 View Post
Sam,
Are you still doing option spreads?
Can you show a little bit of what you do and rationale?
Any forums you recommend?
Thank you.

@meyer99, I've not use options spreads these last few months. I used to trade US stock options, but my account is in Euro, so I also had to hedge my USD positions, and it was a bit too much for me. Options can be a bit complex, so when you add the currency aspect in it, it can be hard to understand and manage.
But I can show few things, if few people are interested.
I didn't found any good forum for options. The thing to do, imho, is to read a couple of books, then paper trade, then trade real cash. It easier to learn like this.

@gio5959: this is gambling. If I want to gamble, I'll do it with horse racing, it's more fun than binary options

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 meyer99 
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Sam,
I am interested in seeing whatever you want to show. Others will show up, I am sure.

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 cbritton 
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DanPickUp View Post
Does anyone use this kind of software for his option trading strategies ?

ThinkorSwim has a nice options layout where you can analyze spreads, make adjustments on volatility, delta, etc. It's free if you don't mind the delay in options data. I used to trade options, but I don't have the patience to wait for results

Regards,
-C

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 shodson 
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sam028 View Post
This kind of strategy exists, but this guy in wrong for few things.
When you sell a Put (we say writing a put), and at the same time you own the underlying (stocks here), this is not a Naked Put.
This is a Naked Put.
Theoptionsguide.com is, I think, the best website for understanding options, all the most commonly used strategies are there.
There is a lot of books on options, I like this one, for beginners, and then this one, which is really great (how to manage you positions).

In fact, I really love options, it's "slow", not like a crazy future contract, but it can be a very very powerful tools. I'm only playing with options spread, no naked stuff, I like to know, when I pull the trigger, what is my maximum drawdown.

I think every trader need to know, a least, what is an option, how do we play with it, and what are the basic strategies.

Actually, selling puts and being long the stock is, synthetically, 2 long positions. He's just selling puts to lower the cost basis of owning the shares, which works well in periods of high implied volatility, which was yielding nice premiums back then, but also obliged him to buy the shares at his strike price if it continued lower through his strike price through expiration.

Naked puts are a nice way to collect some premium for obliging yourself to purchase someones shares (have the shares "put" to you) at a certain price. It's like getting paid to leave a buy limit order open for a certain amount of time, except the order is only triggered if the contract is exercised in the money, not necessarily if that price level is hit.

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 Fat Tails 
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shodson View Post
Actually, selling puts and being long the stock is, synthetically, 2 long positions. He's just selling puts to lower the cost basis of owning the shares, which works well in periods of high implied volatility, which was yielding nice premiums back then, but also obliged him to buy the shares at his strike price if it continued lower through his strike price through expiration.

Naked puts are a nice way to collect some premium for obliging yourself to purchase someones shares (have the shares "put" to you) at a certain price. It's like getting paid to leave a buy limit order open for a certain amount of time, except the order is only triggered if the contract is exercised in the money, not necessarily if that price level is hit.


Selling naked puts is like selling insurance to somebody. I am currently not able to calculate the insurance premium and to evaluate the risk. The Black-Scholes formula ignores tail risk, so I do not want to use it. Selling vertical spreads would allow to increase leverage, but I still would not be able to calculate expectancies or backtest option spreads.

So I am not touching options, as it is far more complicated than trading straight instruments. I admit that I have once sold covered calls.

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For me Naked Option Selling is like a reverse lottery. You collect many times until someone knocks on your door and wants lots of money for the little premium he/she paid. If you want to withstand that kind a drawdown, you need to be capitalized right.

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Naked puts work best when you have a price you want to get into the stock, and collect some premium until price comes down to your price level. The caveat is that once price does come down to your strike, you have to still want to get long at that price as badly as you did when you first sold the put. If exercised, you can trade it, gamma scalp it, sell covered calls, etc, at that point it's a whole new ball game.

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 sam028 
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@Fat Tails is right, it's more complicated than straight instruments. B&S is not very good, everybody knows the story of LTCM, polynomial models are supposed to be better.

What @mattz is saying is not false, but not totally comprehensive, imvho: naked put (or naked call) are very risky, because of their unlimited potential loss, but you're not supposed to wait to much, if the trade is going in the wrong direction. More than with other instruments, risk management is fundamental.

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 mainstream 
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Selling puts is good when the market is selling off and you think you're picking a bottom in a stock you want to own. Otherwise why not just do a spread? Less risk, less reward, less margin required.

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sam028 View Post
@ Fat Tails is right, it's more complicated than straight instruments. B&S is not very good, everybody knows the story of LTCM, polynomial models are supposed to be better.

What @ mattz is saying is not false, but not totally comprehensive, imvho: naked put (or naked call) are very risky, because of their unlimited potential loss, but you're not supposed to wait to much, if the trade is going in the wrong direction. More than with other instruments, risk management is fundamental.

Actually naked puts on stocks are less risky than naked calls. After all price can only fall to zero, whereas a takeover announcement could multiply the price. For index futures the opposite holds true, as downward volatility is always larger than upward volatility, have never seen a flash rally...

Writing naked puts is a lottery, as long as you cannot calculate the expectancy. I can't. The guys from LTCM couldn't either. They did not write puts, but in a way bond arbitrage is similar as it relies on mean reversion as well.

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sam028 View Post
@Fat Tails is right, it's more complicated than straight instruments. B&S is not very good, everybody knows the story of LTCM, polynomial models are supposed to be better.

What @mattz is saying is not false, but not totally comprehensive, imvho: naked put (or naked call) are very risky, because of their unlimited potential loss, but you're not supposed to wait to much, if the trade is going in the wrong direction. More than with other instruments, risk management is fundamental.

I am not sure what you mean by not wait long. Isn't it universal for all trading instruments when you are in a loss?

Here is the real issue with options selling: An instrument could fall /rise by X amount, while the options premium pricing incorporates 5X move way into the future of the underlying instrument. Hence, the premium simply explodes. Take your Delta, Gamma, Theta and they are completely out of whack.

The best example I could use was the Cattle futures that had a move of 150 points limit down about 7 years ago, while the market factored a move of 2,000 points. Way out of the money options were trading like they were in the money.

When you trade options you trade direction, volatility, time and correlation....I'll stick to up or down methods.

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 gtradz 
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sam028 View Post
You can have a look to Visual Options Analyser here, quite cheap. I use an Excel sheet, based on this one, with some "home made" modifications.

Another cheap option (free) is OptionsOracle at SamoaSky - Stock Options Analysis Tools (Strategies & Volatility Analysis, Strategies Screener).

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 pgain 
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naked puts are fine to trade.
But you better do a lot of studying and know exactly what you are doing and why.
Just write one contract for several months and watch how they preform make 50 or 60 bucks here and there and get a feel for it


If it is a stock you want to own anyway and would have no problem getting 100's of shares at a discount
write some puts and wait for the price to come to you.
Writing one or two a month is fine.
the problem is when people get greedy and over leveraged they see the money start to come in monthly selling puts and over expose themselves

Remember if you are a put writer and the over all market turns ( Tanks )you are going to get killed having all you positions put to you. to much one direction bias.


But if you only held a few small positions a month it can be done safely.

As for spreads in my opinion they are much more dangerous than Naked puts. when they hit total loss.
With naked puts you will own the stock and it probally will come back in a month or two.
Actually most brokers will only let you write "cash secured puts" you have to have the dollars in your account to back you the trade


Good luck and go slow.....................Just my 2 cents...........

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 MXASJ 
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The last time I traded naked puts was October 2008, using a strategy that required more testicular fortitude than brains. Let's just say it wasn't my brains that were handed to me on a platter .

I would write naked puts again as part of my long-term core holdings, though, to reduce my cost basis. As pgain points out it does tie up cash, so you need to consider the opportunity cost of that (over and above Rho) when you decide if and what to write.

For example (and don't do this please), if I wanted to add to my Emerging Markets exposure in my long-term portfolio I might consider writing some March 42 EEM Puts. For every put I write, I receive $115 but my broker will require me to keep $4,200 in cash. Between now and March could I make more than that using that $4,200 as margin to day trade 6E or something else? That's the kind of thing you need to consider.

And of course if EEM drops to 18 again between now and March you are in for a bit of pain, but that works for some long-term.

Then there is the whole Vega thing but let's not go there now...

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 fluxsmith 
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Fat Tails View Post
...So I am not touching options, as it is far more complicated than trading straight instruments. I admit that I have once sold covered calls.

I'm always amused by the misconception (not saying Fat Tails has it) that naked puts are risky and covered calls are conservative. For a non-dividend paying stock they are virtually identical. A naked put could be considered a synthetic covered call.

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 tigertrader 
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The bible on options trading has always been recognized as " Options as Strategic Investment" by Lawrence McMillan

I would also highly recommend:


Option Volatility & Pricing
by Sheldon Natenberg - the bible on vol

The Volatility Edge in Options Trading
by Jeffery Augen - one of the best books on vol

and
Options Trading by Charles M Cottle - because I used to trade with him and he's a friend

Please notice that volatility is a recurring theme in the above titles. If you are going to trade options you need to understand 3 things...volatility, volatility, and volatility.

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 Jura 
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Interesting thread here. I got an short naked options question, and I was hoping that someone could help me out.

I was calculating the results of an Short Strangle (selling out-of-the-money put and the selling of an out-of-the-money call with the same expiration date). Let's say you sell a call with an exercise of 420, and a put with an exercise price of 330. The underlying index currently trades at 370, and you receive an premium for selling both options of 1.20, which results with an contract size of 100 into $120.00. With that, I calculated the following results at expiration: (see attachment)

My question is: are these values correct? I've triple checked my calculations, but the risk/reward ratio seems so way off (earning a combined premium of 120 and potentially losing 5000 when the underlying moves more than say 14%). I know that these option strategies have high risk compared to their received premiums, but this extreme?

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Arpeggi
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Jura View Post
Interesting thread here. I got an short naked options question, and I was hoping that someone could help me out.

I was calculating the results of an Short Strangle (selling out-of-the-money put and the selling of an out-of-the-money call with the same expiration date). Let's say you sell a call with an exercise of 420, and a put with an exercise price of 330. The underlying index currently trades at 370, and you receive an premium for selling both options of 1.20, which results with an contract size of 100 into $120.00. With that, I calculated the following results at expiration: (see attachment)

My question is: are these values correct? I've triple checked my calculations, but the risk/reward ratio seems so way off (earning a combined premium of 120 and potentially losing 5000 when the underlying moves more than say 14%). I know that these option strategies have high risk compared to their received premiums, but this extreme?

Try graphing what it will look like before expiry. Option p/l graphs are always a little misleading because they only tell you what is going to happen at expiry, not with 200 or 100 DTE. Before then, you might have to find an iron stomach to endure the stress.

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 fluxsmith 
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Jura View Post
...I've triple checked my calculations, but the risk/reward ratio seems so way off (earning a combined premium of 120 and potentially losing 5000 when the underlying moves more than say 14%). I know that these option strategies have high risk compared to their received premiums, but this extreme?

Haven't checked your math, but the picture looks right, and yes, the losses on a short strangle or straddle can certainly be that extreme. If you find a short strangle otherwise appealing, I think you need to look at Iron Condors.

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 meyer99 
Charlotte NC
 
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Just wanted to show what we can chart now with Kinetick EOD.
This chart shows the ES and its associated volatily: the VIX. There are volatility indexes for oil, gold, euro, etc. Search on the CME web page if you need them.
To get VIX on Kinetick edit the symbol to read VIX.XO and point to CBOE for exchange. Same for other indexes.
Do this while connected to Kinetick.
I hope it helps.

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 gvv1965 
Rome, Italy
 
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Jura View Post
I was calculating the results of an Short Strangle (selling out-of-the-money put and the selling of an out-of-the-money call with the same expiration date). Let's say you sell a call with an exercise of 420, and a put with an exercise price of 330. The underlying index currently trades at 370, and you receive an premium for selling both options of 1.20, which results with an contract size of 100 into $120.00. With that, I calculated the following results at expiration: (see attachment)

My question is: are these values correct? I've triple checked my calculations, but the risk/reward ratio seems so way off (earning a combined premium of 120 and potentially losing 5000 when the underlying moves more than say 14%). I know that these option strategies have high risk compared to their received premiums, but this extreme?

Jura,
I just joined futures.io (formerly BMT), so sorry for the late answer and especially for my italo-english.
There are a few biases in your analysis; some of them has already been underlined, other not.
Let's start with the first one: your expectations. when selling a straddle or a strangle, you are playing eminently a range game, i.e. you expect your stock (ETF or whatever, call it ABC) will be in a range from now to expiration AND/OR you expect that ABC, after maybe an explosion in volatility, will calm down and therefore volatility will decrease.
Going into more esoteric details, you are playing a negative theta game, i.e. you expect the time to work for you, by decreasing the value of your short options day by day (but this is indeed something that becomes much more visible near expiration and if volatility is decreasing, that is equivalent to -let say- a shortening of time remaining). Finally, if you are an option expert, you might want to play some negative gamma scalping, but that's probably too far for your experience.

Second issue: Naked Options Variables, like Expiration and Volatility, just to cite the most important. How far are the expiration are you calculating expected results for? 1 day? 1 month? more?. As per the previous point, the nearer the expiration, the higher the theta, i.e. the value the naked options lose each and every day. What is the volatilty of ABC and the implied volatility embedded into your options? The greater the volatility, the greater the value of the options you sell and the returns, of course, BUT the greater also the risk, since a volatile issue has much more chance to go beyond the boundary of your strangle AND is not affected that much by the effects of time passing by, until the very days before expirations.

Let's see an example, made with a sample stock, approx 60 DTE (exp on May 20th, 2011), an average volatilty of 20%. These parameters yelds a 119 credit selling the options (like in your case), that is your maximum gain potential. Please note that in a short strangle, your maximum loss is unlimited so it's a matter of probability whether you will be proftiable or not. In other words, what is the probability that ABC will be btw 329 and 431 by expiration?
Assuming that our current volatility estimate (20%) is correct, by May 20th you have almost 90% of chances that ABC will be in your sweet spot of profit, however, if volatility grows to 30% in the period (or if for whatever reason the implied volatility of options grows) your chance of profit falls to 72,6%; 58,8% if it doubles to 40%.
Do not forget, furthermore, that, if volatility increases, it's like if time to expiration slows down, so your naked options lose less and less of their value (and this is not good for your position).
These are only estimates and they ar as good as the underlying model is (garbage in - garbage out), so the question is: why unlimited risk naked premium if you can choose some limited risk strategies, still based on naked premium, but not endangering your financial and mental health.
Using the same parameters above, buying a further OTM strangle (450 call and 300 put) will cost you less than 15 bucks and will limit your exposure to 2895 on the downside and around 1900 on the upside.
As per my experience, I think that naked premium selling is only for hugely capitalized guys, who can afford shorting premium-rich ATM or near-the -money options in a variety of markets, playing the odds of probability, but always having some further OTM options long as "protective wings" for their naked position, being therefore protected, should the black dawn materialize from time to time (more often recently), that same black dawn that destroys our "private ryan's" positions and accounts.

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