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CXMelga

Is the following a stratergy the others might use?

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Hello,

At the moment I am new to options and selling OTM credit spreads (above and below the market). I try to sell OTM spreads where the POP of being ITM is 30% or less

I have quite a few positions open at the moment (%5 or less of account on each) across various sectors, but it is too early to say if this is going to work out for me

Naturally as this is a defined risk strategy the net premium (and therefore my profit) is limited because of the long strike (hedge)

So, I was thinking about the following, (if I have more time to keep my eye on the market)

Sell naked puts or calls very OTM as above, so more potential profit as I do not dilute with a long strike, (but more risk), the idea being  want the market to move away from my strike

Then if the market moves closer to my strike (depending on the level of move), let say I sell a call and the market is moving up, I could sell a put below the current market to get some premium (naked again), and if the market continues to move up perhaps sell another put and another (to get more premium)

Then if the market gets to close to my strike (e.g. sold call in this case) for my personal comfort buy a long strike to create a spread (hedge at that point). I know the long strike would be more expensive than if I have brought it in the first instance, but the credit from my short puts should help overcome this to some extent or completely.

I figure, if I sell 100 contracts, and each is far OTM and say 20 of these 100 contracts do not work out, as long as I do the above overall I could make more profit.

The big danger of course is an underlaying jumps or falls quickly through my short strike before I get  a change to react.

On that last point I suppose it would be possible (depending on the platform) to setup a BTO order but only if XYZ reaches (or falls) to a certain price (e.g. automatically buy my long strike if I am not in front of the computer).

I am not asking anyone if I should or should not do the above (my risk) but want to know if anyone else uses this strategy (I assume so and how prevalent the method).

Thanks very much

CXMelga

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@CXMelga, what you propose is the basis of option selling. Selling naked strangles is a widely used technique - and one with a slightly bad rep. It works for months or even years and then one big move in the market leads to a blowout. You have no doubt read about the recent optionssellers.com debacle. Then there is the 'Karen the Supertrader' story. There is a myriad of Youtube videos and articles online on how to get a decent income selling options. Options Alpha is a subscription service based mainly around selling from what I remember.

 

Newbies - myself very much included - when they find out about selling naked strangles and the easy money it provides, think they have found the holy grail. They start receiving premium regularly, and enjoy watching the value of their short calls/puts decline daily from the theta decay. Then comes the killer blow. A massive move down (or up) leads in increases in volatility and premium and the puts (or calls) you sold for 20 are now priced at 80. Do you close at this loss or do you hold on waiting for a reversion? Sure, in theory, we can have a stop-loss, but from experience most people who sell nakeds (myself very much included) have poor risk management in place. Also, having stop losses means that you will get stopped out a lot of the time when the underlying then reverses and you could have closed your position at a good profit, if you had only ignored your stop-loss and held on. This will severely impact your overall profit. But then not having a stop-loss means you risk that killer blow.

 

Personally, I have been trading naked strangles for around 9 years. Solid profits year after year were followed by that one big crunch which would wipe out all of last years gains. The reason I did strangles is due to scalability - you can literally trade a multi-million $ account with these, without blinking an eye-lid. Now, there is nothing more undignified than grown men playing the "My 'portoflio' is humongous" game, and that's not the intention here, but I trade via my own Limited company (equivalent to the US version of 'Inc'), so I treat this like a business. I still have some strangles in my account, which I am trying to close out and most will be done and dusted within a couple of months. (For reference, I have had them for nearly two years - and kept rolling them as the SPX kept going up and up and up.) Once they are closed, I will no longer sell nakeds again. I've learnt that being able to sleep well at night is an important part of trading.

 

If this is something you want to try, my tips would be :

 

- do it on a leading index like SPX (immense liquidity; has almost daily expiring options (Mon/Wed/Fri) so you can be creative with reducing margin by buying near-dated longs against long-dated shorts, etc.) Use cash based, European style expiry indexes as opposed to ETFs or stocks so there is no dividend risk, no early assigned risk and no company-specific event risk.

 

- NEVER use up more than 50% of your account margin. It's easy to over-leverage and double-down, thinking you're onto a sure thing. The market can, and will, take it's money back at a very short notice. And it won't feel guilty either.

 

- Diversify - as well as different sectors, use different asset classes (equities, commodities, treasuries, etc). If you chose to focus on equities for now, you can still diversify to some extent by doing the following : selling at different time expires (eg. some shorts expiring next month, some in 3 months); selling at different short deltas (selling some shorts at say 10 delta or selling a much smaller quantity at say 30 delta); doing a mix of naked strangles and credit spreads, doing iron condors, ratio spreads etc.

 

Happy trading.

 

 

 

 

 

Edited by zxcv64

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