I thought I would share a sort of activity in which I was engaging for a while (but find no opportunities of late). I have seen related discussions recently in online forums.
The basic idea is that given an equity one finds quite attractive at a price only somewhat below its current price, one can sell naked puts to reach that attractive price goal. [MDW note: Yes, if assigned an exercise notice]
The added twist in which I had been engaged was to risk the same amount of capital in a single strike separation bull put spread [MDW Note: sell a 45/50 put spread, for example] (or perhaps some other width, depending on the numbers).
A rapid collapse through through the short strike would make me uncomfortable about the possible losses, but allow for the sale of most of the long puts and purchase of all short puts (under those market conditions, providing some profitability to the downside ).
Now the absolute amount at risk has not been reduced, but the rate of loss most certainly has. The goal of acquiring stock at or near the strike price is nearly achieved.
As it happens, I did not have any outsized gains from this activity,nor did I acquire any stock. The consolation prize (outsize gains being the goal) was collected in each case when the market bounced and sudden euphoria set in.
I am now trading ICs in some markets. I am starting to feel uncomfortable about this — just on an instinctual/gut/superstitious level (yes, I have more on in index ICs). My concern is all the short vega.
Thanks for sharing.
There is a fallacy embedded within your idea. Although the stock can fall to zero, it's extremely unlikely. As a result, the maximum theoretical loss when writing the naked put is almost never realized.
On the other hand, it's much more common for the stock to move through both strikes of a put spread, resulting in (assuming no adjustments) the maximum theoretical loss. Thus, the reason an 'equivalent amount of capital at risk' is not the correct way to equalize risk. The probability of incurring that loss must be considered.
If you are considering selling 5 Aug 60 puts @ $3.00, the potential loss can approach $30,000 (Buy 500 shares @60, stock goes to a low price near zero, minus $1,500 premium collected), but in reality, that potential loss is less. There's always time to get out at some price to salvage a portion of your investment.
Compare that play with selling 60 Aug 55/60 put spreads @ $1. The maximum loss for 60 such spreads is $30,000 – less the $6,000 premium collected. Of course, you can use that premium to sell even more spreads, but let's ignore that possibility for this discussion.
Which of these positions is more likely to earn a profit?
Which can earn the higher profit?
Which is more likely to incur a significant loss?
To earn a profit,the stock must not be much lower than 60 when expiration arrives. For the naked put trade, the break even point is $57, and it's $59 for the put spread sale. Thus the naked put has a better chance to earn a profit.
But there's $6,000 potential profit when selling the spread compared with one fourth that amount for the naked put sale. That makes the spread look attractive.
But that attractiveness disappears when you consider potential losses. If the stock moves to the low 50s at expiration, the naked put seller loses approximately $4,000 less premium, or $2,500.
The put seller loses the maximum, or $5 per spread (less $1 premium). That's $24,000.
These positions can hardly be considered to have the same risk. And that's the fallacy in the argument of 'I'll risk the same amount of capital.'
One point I stress in The Rookie's Guide to Options is that the real danger of selling put credit spreads is being unaware of just how much money can be lost. That encourages many option traders to sell far more spreads than justified. 'Size kills' is an appropriate expression used by investors who understand risk. You cannot afford to be greedy by taking more risk than your experience and pocketbook can handle.
Regarding the iron condors: Although short put spreads have risk associated with short vega, it's only half as much as the iron condor. If negative vega is uncomfortable, consider combining double diagonal spreads with iron condors. Another reasonable decision is to avoid iron condors and use strategies that are nearer to vega neutral.
Late ADDENDUM: Those profits of which you write that you collect on the downside are a figment of your imagination. there are no profits. Only losses. If you are considering selling all your longs and covering just a few of your short puts, that is a huge gamble.
Please rethink this.