Selling Naked Calls?

Ok, i see whats going on. When i refer to options as being zero sum, i'm talking in cash terms... of course in utility terms they are not zero sum.


Second, i never claimed that you would be a sucker to buy options when their EV is negative... thats my whole point... that option sellers get a positive EV but that this is to be expected and a fair risk premium.

>>Add that to the fact that there are experts out there with big money who can easily afford the risks on both sides. Doesn't it stand to reason that they will drive down the price of an overpriced option? >Obviously if it is true that selling naked options is a bad play it would be because of the rare calamity that would befall the naked seller. >But because of its rarity, meaning that the great majority of naked sales show a profit, might it not be that this widespread belief that selling naked options is positive EV, is in fact wrong? > I believe we have readers out there who KNOW the right answer to this question and I hope they tell us.

...Add that to the fact that there are experts out there with big money who can easily afford the risks on both sides. Doesn't it stand to reason that they will drive down the price of an overpriced option?...


Of course this is true for a lot of stocks but as Ray has pointed out many times that the big money stays out some stocks basically because there isn't enough liquidity. I suppose that some opportunities may present themselves because of this.


...Obviously if it is true that selling naked options is a bad play it would be because of the rare calamity that would befall the naked seller. ...


IMO there is a big difference between shorting puts and shorting calls so I assume we're talking about shorting calls.


...But because of its rarity, meaning that the great majority of naked sales show a profit, might it not be that this widespread belief that selling naked options is positive EV, is in fact wrong?...


FWIW I don't think in general that shorting calls is +EV. I don't think options are priced that way and from my understanding market makers generally don't assume the risk of a short call, they transfer the risk and are basically involved in an arbitrage activity for lack of a better term.


...I believe we have readers out there who KNOW the right answer to this question and I hope they tell us. ...


I really don't know of any particular study but I'll try and find one. I can't prove it but I actually believe that right now there are many under priced out of the money calls in several of the big cap NASDAQ tech stocks. Again I can't prove it but I think buying slightly out of the money calls will be profitable for 2002. If I was employing such a strategy I'd go long the calls for the next month the day the previous month's options expired and buy them each month expecting to lose more often than I win but when I win it would more than make up for the losses.

>IMO there is a big difference between shorting puts and

> shorting calls so I assume we're talking about shorting calls.


Please don't make this common blunder.


There's little difference in the results

of being short massive positions

in low price Calls or in low price Puts.


Almost half the traders mentioned went,

one way or another,

on October 19, 1987.

I believe you Erin.For the 3 quarters prior to the crash my friends and I talked about pooling about 15k together to buy S&P puts.We felt the market was overvalued and we were going to buy a bunch each quarter.Woulda,shoulda,coulda, we never did.We did sell some way out of the money calls at ridiculous prices after the crash however.

You know, that average floor-piker who lost 52.5 million in two days? (CBOE, OEX puts.)


I think Tom's blunder may be more accurate when applied to off-floor/retail traders. Floor traders often get wrecked by fast moves and gaps, which happened plenty to the upside in CitiCorp, Chrylser(?), other buyouts, and throughout the Internet era.


But for off-floor traders, usually any big move over time is a gap - since they don't hedge dynaimically - and they are usually net long the market. Since they post monster margins, the move of a size required to blow them out would have to be some surprise negative revelation about a company.


When we talk about stocks shooting to the moon, and covered call writers and mutual-fund investors, usually it feels more like oxygen than the Option Grim Reaper.


Also, it may very well be that bond options have a lot of volatility because people have a long memory going back to 1982, and the absolute Keynesian/Argentina doomsday scenario.


eLROY

I am just a mathematician in finance, basically a brownian motion specialist and what I am saying might not be of any interest for you.

However it is worth noticing that far out of the money vanilla options are directly used in the hedging of exotic European options.

This is due to the Peter Carr's theorem which states that the price of every C² European payoff functional can be replicated as a weighted sum of vanilla options at different strikes (including far out of the money strikes). What is beautiful is that you heve a direct exact hedging of the option without making usual greeks hedging.

This can also be extended to interest rate options as a weight sum of vanilla caps/floors.

And I know for sure that a few years ago some banks did not understand why major banks did sell such far out of the money options and it was because of the above mentionned reason, that is the hedging of exotic OTC options.

read "why some major banks did buy such far out of the money options" obviously

At the following link, so far as I can remember - and given my limited mathematical ability - Derman suggests that you can hedge volatility by buying a continuous portfolio of long options, or something:


http://www.gs.com/qs/doc/volswaps.pdf


Is that basically the idea? Or did I miss something?


Then, buried deep in the following post, I argued that, based on the inverse correlation between stock prices and uncertainty, that you could probably construct a simpler hedging strategy for volatility:


http://www.twoplustwo.com/cgi-bin/ne...s.pl/read/1627


Might you do me the favor of, like, correcting my paper here - explaining in non-mathematical terms where I have been led astray?


Also, please tell the forum more about what you mean by vanilla versus European/exotic options, and how it is relevant. I might not understand it, but someone will!


Finally, so far as Brownian motion, I would not dismiss it, but rather celebrate it as the number-one fair-value discovery tool in all of finance!


leroy

I didn't bother reading the articles you referred

to.I can state the following should you choose to belive it fine.I only stae it from my 20 plus years of experience.When it is possible you should hedge options with options.Other wise you end up

"delta-trading" which to me means buying the highs and selling the lows.