SteadyOptions is an options trading forum where you can find solutions from top options traders. TRY IT FREE!

We’ve all been there… researching options strategies and unable to find the answers we’re looking for. SteadyOptions has your solution.

Is Your Risk Worth the Reward?


One of our members posted a link to an excellent post from Mark Wolfinger. Mark responded to a question from one of his readers: "For the past 2 years, I've been selling naked options (mainly puts, a few calls) to generate monthly income. My position returns just over 1% per month on average on the total account value".

After 7 years of bull market, many traders forgot the meaning of risk. They think they can just buy call options and/or sell puts and make outrageous digits returns every year. I suggest that everyone reads Mark's post, it's an excellent read with a lot of wisdom.

 

Is selling naked puts a good strategy?

 

Mark's response is fairly long - here are the most important points:

 

"This is not a conservative strategy. Not even close. It is a high probability play, with many profitable months. I cannot imagine a strategy in which I earn a profit month after month for several years. Yet this strategy could provide those results. The question is: how much is at risk?

 

No matter what anyone tells you about risk, you just know that either nothing terrible is going to happen, or if it does happen that you will react in plenty of time. Let me assure you that in Oct 1987, puts were not buyable at any price that you would have been willing to pay.

 

You did live through the winter of 2008, but if you have truly been doing this for 24 months, you began at the right time. You missed out on the excitement of Sep and Oct of that year.

 

Have you considered what would have happened had you begun in August 2008, instead of 3 or 4 months later? If you have access to TradeStation (or if your broker offers back-testing – I believe thinkorswim does), go back to August expiration, choose options to sell for the Sep and Oct expirations and then follow the trades." 

 

I am NOT telling you what to do, but you have not been through what I have.  You have not seen how quickly money can vanish from your account.

 

What is your risk/reward?

 

We are familiar with some services that advocate selling naked puts on 25-50% of their portfolio. In our opinion, this is a financial suicide. This strategy obviously performed very well in the last few years. Interestingly enough, the track record of those services usually doesn't go beyond August 2011, not to mention October 2008. One of them has data going back to 2009 (again, not 2008 ), but August 2011 is missing. Coincidence?

 

To give a fair margin of safety, the strikes are usually far enough from the money to give you around 2-3% potential return on margin. Well, 2-3% per month sounds very good, but what about the risks? In a month like August 2011 (not to mention October 2008) the loss could easily reach 30-50%. In October 2008, it could wipe out your account. Is 2-3% per month worth the risk?

 

The latest case of Karen the Supertrader who implemented similar strategy of selling naked options provides a good example of the risks.

 

How our strategies handle risk?

 

Let's take a look at our strategies and see how they handle risk.

 

SteadyOptions

 

At SteadyOptions, we trade a mix of non-directional strategies. They might include Iron Condors, Calendars, bufferflies, earnings straddles etc.. The idea behind earnings straddles is buying a straddle 5-10 days before earnings and hold it till earnings. The strategy is based on my Seeking Alpha articles Exploiting Earnings Associated Rising Volatility and How To Rent Your Options For Free. We expect the IV increase to offset the negative theta and/or book some gamma gains in case the stock moves.

 

In periods of low IV, the earnings trades are expected to produce 3-5% average return, and theta positive trades like ICs and calendars are expected to provide us most of the gains. However, the earnings trades serve as a nice hedge to the theta positive trades in case of a quick and sudden move. To see how they performed when the markets become volatile, take a look at August 2011 returns here or July 2012 returns here. Those trades are basically our black swan event insurance, and we get it for free - in fact, most of the time we even make some money on it.

 

Anchor Trades

 

An Anchor trade's goal is to prevent loss of capital while still generating a positive net return in all market conditions. This strategy began with the premise that it must be possible to virtually fully hedge against market losses, without sacrificing all upside potential. It is expected to lag the S&P 500 in a strong bull market like 2013. In 2013 the lag was larger than expected due to poor selection of stocks. Going with ETFs instead of stocks would lag the S&P only by few percentage points, which means that the hedge almost paid for itself.

 

The impact of not experiencing losses in down market years, while only slightly lagging (if lagging at all) in positive and neutral years, is astronomical over any extended period of time. Again, it is very easy to become complacent in the current bull market - but the market will correct at some point. It's not a matter of if but when. And when it does, you will be thankful that you are hedged. As an example, the Anchor return in May 2012 was +4.6% while S&P plunged -6.2%. In 2008 when S&P was down 38.4%, the Anchor was up 27.9%.

 

Steady Condors

 

Steady Condors is a market neutral, income generating, manage by the Greeks strategy. The trades are primarily risk managed variations of iron condors. The big difference (in addition to how the adjustments are made)between the Steady Condor main trade (MIC) and the "traditional" Iron Condor trades is the fact that MIC uses a put debit spread plus some far OTM puts for black swan event protection. This protection is placed when the trade is initiated - in other words, we buy protection when we want to, not when we need to. The result is that in case of market crash or black swan event, the trade actually becomes vega positive and those hedges provide an excellent protection.

 

We conducted a case study for the August 2011 trade (available on members forums). It's a fascinating read. During the life of the trade, RUT was down over 11% - yet the trade was closed at profit target of 5% on Aug. 4. Interestingly enough, on Aug. 8 RUT closed down 64 points at 650. If you wouldn't have taken the trade off on the 4th the trade would actually have been up 67% at the end of the day on the 8th. This is the power of protection, combined with exploding Implied Volatility.

 

Conclusion

 

When comparing different strategies, don’t forget to consider both historical performance AND historical drawdowns in both up and down markets. Mark asks the following question: "How much will you lose if the market opens 20% lower one day, RUT IV (RVX) moves to 90 or 100, and the option markets get very wide?This is your stress test - does your portfolio pass it? 

 

Want to see how we handle risk?

 

Start your free trial

Edited by SteadyOptions

What Is SteadyOptions?

Full Trading Plan

Complete Portfolio Approach

Diversified Options Strategies

Exclusive Community Forum

Steady And Consistent Gains

High Quality Education

Risk Management, Portfolio Size

Performance based on real fills

Try It Free

Non-directional Options Strategies

10-15 trade Ideas Per Month

Targets 5-7% Monthly Net Return

Visit our Education Center

Recent Articles

Articles

  • Investors Are Not As Smart As The Media Thinks

    Over the last decade there has been a substantial rise in proclamations such as “investment advisors are useless,” “manage your own assets,” “don’t pay for financial advice,” and other similar sentiments. 

    By cwelsh,

    • 0 comments
    • 84 views
  • Should You Close Short Options On Expiration Friday?

    Options traders spend a lot of time trying to figure out the perfect moment to open a trade; but little attention is devoted to the other side of the transaction. When should you close? This applies equally to long and short positions. However, one aspect of short timing concerns expiration Friday.

    By Michael C. Thomsett,

    • 0 comments
    • 261 views
  • 8 Strategies For High Volatility Markets

    Trading in high-vol environments requires a different approach from low-vol markets. Here are 8 strategies to improve your trading and help you to survive in high volatility markets. They are very different from strategies in low volatility environment.

    By TFCAB,

    • 0 comments
    • 134 views
  • Selling Options Premium: Myths Vs. Reality

    Selling Options Premium refers to certain set of strategies that involve net selling of options, as opposed to buying premium where you are net buyer of options. There are a lot of myths and misconceptions about Selling Options Premium. This article will explain the basic concepts and debunk some of the myths.

    By Kim,

    • 0 comments
    • 590 views
  • Combining Momentum and Put Selling (Updated)

    In February of 2017, I wrote an article about combining together the concepts of momentum and put selling. You can find that article here as prerequisite reading. With this post, we'll look at how the strategy presented has done since then, along with some additional implementation ideas.

    By Jesse,

    • 2 comments
    • 443 views
  • Options and Invisible Risks

    Entry and exit timing is crucial to successful options trading, without doubt. However, one form of risk not often acknowledged is the risk of taking too many actions, too soon, and for the wrong reasons.

    By Michael C. Thomsett,

    • 0 comments
    • 487 views
  • The Volatility Option Trade In Alibaba

    This is why you have a Trade Machine membership. We can ride the evergreen patterns, and we have, for years. But when the market shifts, we need a minimum amount of data to adjust, and succeed -- now we will. This is our time.

    By Ophir Gottlieb,

    • 0 comments
    • 707 views
  • James Cordier: Another Options Selling Firm Goes Bust

    On November 1, 2018, a money manager named James Cordier from OptionSellers.com published an article on Seeking Alpha named Option Selling Opportunities So Good They're Scary. To me, this title alone would be enough to completely discredit the author and not trust him with my hard earned money.

    By Kim,

    • 10 comments
    • 4,899 views
  • Do You Have a Written Investment Plan?

    Meb Faber recently polled his twitter followers, and found that only about 25% have a written investment plan. Your investment plan should be based on your willingness (risk tolerance) and need (required rate of return to meet your long term goals) to take risk. 

    By Jesse,

    • 0 comments
    • 527 views
  • Options Delta And Other Greeks

    The most worthwhile of the "Greeks" for options trading (and specifically for timing of trades) is options delta. This indicator looks at likely change in option value relative to change in the value of the underlying. The higher the delta level, the more likely the premium will move more than movement in the same direction for the underlying.

    By Michael C. Thomsett,

    • 0 comments
    • 631 views

  Report Article

We want to hear from you!


There are no comments to display.



Your content will need to be approved by a moderator

Guest
You are commenting as a guest. If you have an account, please sign in.
Add a comment...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...

Options Trading Blogs