Selling Naked Index Options


Thanks for the ongoing education.You run a great blog and I enjoyed your 'Rookies' book enormously.

For the past 2 years, I've been selling naked options (mainly puts, a few calls) to generate monthly income.

I sell WAY out of the money RUT puts in the front 2 months using an initial margin limit of about 35-40% in my portfolio margin (PM) account at Interactive Brokers.

I keep the account about 65% invested in dividend paying ETFs and stocks, 35% cash.

As an example, With RUT around 740, I'm currently short the following options:

RUT Dec 540 P
RUT Dec 580 P
RUT Dec 590 P
RUT Dec 810 C
RUT Jan 480 P
RUT Jan 500 P
RUT Jan 540 P
RUT Jan 850 C

I normally sell puts with a premium around $1.00; calls around $0.40.

My position returns just over 1% per month on average on the total account value, which is more than sufficient for our needs.

Over the past 24 months I've had just 2 losing months, in each case losing about one month's average income.

I wonder if you could comment on this strategy? I like to think this is quite conservative, but a catastrophic drop in the market wouldn't be nice…

Should I consider selling credit spreads instead? I assume I would need to operate closer to the money to generate similar returns and spend more time adjusting my positions.




Hello Steve,

1) NOTE about Portfolio Margin: $100,000 minimum balance is required for a PM account.  In addition, margin is calculated more leniently than for Reg T margin accounts.  That means you can sell many more options than a non PM customer.  Another way to look at that is you can sell far more options than are good for you.

2) 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?  That is very difficult to answer.  More on that later.

3) Your last sentence explains the dilemma.  Yes, you would have to sell closer to the money options if you chose to sell credit spreads instead of naked options.  Yes, you would spend more time making adjustments.

The question is:  Which is a better situation for you and your money: your current strategy or the alternative of selling credit spreads.  And it's a good question with no simple answer.

To me, this is a no-brainer.  I prefer to be in the situation of making adjustments, knowing that my losses are limited and that I cannot go broke overnight.

So far, you have come out well.  You had two losing months and I'm anxious to learn how you handled them:  Did you adjust to reduce risk, or did you hold to the bitter end (expiration)?  And when you say 'losing months' does that refer only to the naked option selling, or dos that take into account your significant position in ETFs.


I will never again sell naked index options.

4) 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.  I understand your situation.  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.  I know I thought just those thoughts.  The people who managed risk for a living were just being silly when they told me that I have more risk that any other market maker in the clearing firm (and it was First Options, a very large clearing firm).

I thought that I could handle it.  Even after having been hammered more than once, I made the same mistake again. All I can do is relate the story, issue a warning, and allow you to make your own decisions.

Let me assure you that in Oct 1987, puts were not buyable at any price that you would have been willing to pay.  Incredible as it may seem, in many stocks, the bid/ask spread for options was 10 points wide and the asking price for some puts was more than the strike price.  Imagine being asked to pay $32 to buy the Nov 30 put – an option that could never be worth more than $30.  But when customers were  told they had to cover short positions and they had to buy their options at the market price – and do it right now, they paid whatever they ahd to pay. I have no idea whether anyone had to pay above the strike price for puts, but that was a common asking price.

Next, consider the poor customer who was short calls.  When IV explodes, far out of the money calls do not sell for tiny fractions. The premium expands.  Those who lost tons of money by being short puts were forced to cover their short calls as well.  No consolation there because they had to pay obscene prices for puts.  Obscene.  And this was not the market makers taking advantage of customers.  The prices were high because maraket makers had to buy calls to protect themselves.  They were selling lots of puts and also shorting stock, when there was an uptick.  The only way to protect the upside was to buy calls.  So call prices were bid higher.


Back to you Steve

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 don't know how much risk you are willing to take, but your note warns me of the danger.  You claim to earn $1,000 per month per $100k in your account.  You also say that's enough money for your needs, so I'll just guess that this is a half million dollar account and that you pull out $5,000 every month, on average.

You have 65% of your available margin invested in ETFs.  If the market crashes, dividends or no dividends, this is not going to be pretty.  I assume that you look at risk from the vantage point of those short put options but I don't believe you are considering how much worse it will be because of these ETFs.

If you believe you know what fear is – you have no idea.  Imagine a catasrophe in which the market is plunging, IV is exploding, bid ask spreads are getting wider, half of your account is already gone, you want to buy puts but don't know where to begin, and your broker is blowing our your positions (by paying the ask price) to cover your now sky-high margin requirments.  Whenever you enter a bid, the ask price just mves higher.   That's fear. 

I believe you need to do something better with your money.  I want you to know that I NEVER suggest how anyone should trade or how anyone should invest.  But in your case, all I am trying to do is to be CERTAIN that you understand risk.

Consider this:  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?  You must have this number in the back of your mind.  You must have some idea of 'just how bad this can get.'

If you can live with that loss, then you are ok in my book.  This strategy may wowrk for you, after all.


Reasonable Compromise

The fact that you ask about selling spreads instead of naked option tells me that risk is a consideration for you. 

To trade credit spreads, you would buy one option for each option sold.  If you still like the idea of being naked short options, rather than short credit spreads, try this compromise:

Continue to sell options as you do.

But do not hold to expiration.  in fact, cut your holding period considerably.  If you sell at $1.00, then buy them back.  Choose a price.  Maybe 40 cents.  Maybe 25 cents.  It does not matter how far OTM they are.  Buy them back.

I note you are short several different stike prices.  A different compromise is to be short far fewer options.  When you sell a new put, cover the old put.

This is not anywhere near an ideal situation because you will still be short naked options.  However, you will hold each short for less time, ad that cuts risk.  You will hold fewer short options at any one time, and that cuts risk.  you will earn less cash, and the one thing that you must not do is increase size to compensate.

I don't like your strategy, but if you understand what can happen – and how difficult it will be to put out the fire – and if you are willing to accept that, then that's your well-reasoned decision.  But if you just don't get how bad it can get, then you are taking on more risk than you understand.

Whatever you do, I wish you the best.  Just be careful out there.


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26 Responses to Selling Naked Index Options

  1. Martin P. 12/02/2010 at 5:40 AM #

    Hi Mark and Steve,
    I would suggest one more option for compromise:
    – Sell naked option as you do normally.
    – But buy protective put 10, 20 or 30 or more points lower.
    – This protection will cost you almost nothing in this case far OTM options.
    – It will cost you 1 comission (and IB has lowest commission in the industry) and lets say 2-10% of your premium or fewer.
    – It will give you certainty of maximum loss in any case.

    • Mark D Wolfinger 01/10/2014 at 8:56 AM #

      Martin that is all true. And I strongly recommend selling put spreads rather than naked puts – unless the trader’s goal is to accumulate stock.

      However, there is not much point in buying option that are 20 to 30 points OTM – unless you are selling index options, as we are in this blog post.

      However, for the person who trades individual stocks:
      For example, if you sell a put struck at $60 for a specific stock that you like, would you really want to be protected against the stock falling below $30 or $40 per share? Surely that is not the kind of protection that is needed.

      I would encourage you to buy the $55 put and accept a significantly smaller return on your investment – if protection is something that you need.

      To reiterate: When trading index options, you and I are in total agreement. Protection is mandatory.

  2. Bill Burton 12/02/2010 at 6:27 AM #

    Great discussion on risk. Never forget that “Black Swan” events do exist and often appear at the most inopportune times. While clearly infrequent, such events can be fatally damaging to both emotional and financial capital.
    Mark and Martin have both suggested ways to control risk a bit more than your current program. It is really hard to accept the possibility of the existence of such events if you have never experienced them. I echo both their sentiments and suggest you try to implement some strategy to insure survival should the Black Swans arrive unannounced as they always do.

  3. Brian 12/02/2010 at 7:10 AM #

    If I’m not mistaken, wasn’t selling naked options the strategy (or one of them) that blew up the LTCM firm back in the late 90’s?

  4. Steve 12/02/2010 at 8:03 AM #

    Many thanks for the detailed reply.
    Just a clarification of my account details. I have 65% of the account invested in ETFs and stocks – not 65% of margin.
    Using the figure of $500,000 suggested by you (not too far from the actuality), that means I am long $325,000 of ETFs and stock with $125,000 in cash.
    Therefore, of the $200,000 (40%) margin, $140,000 (28%) relates to options and $60,000 (12%) to ETFs and stocks.
    One of my losing months was May 2010. I lost by exiting early as the market dropped. One of my losing positions was an SPX May 1000 Put. Sold in April for $1.00, bought back on 05/06/2010 for $4.00!
    As with almost all my losers SO FAR, if I had hung in, I would have made my $1.00 (the SPX never reached 1000). At the time, the position seemed awful. It cost $3.00 to buy back one day, $4.00 the next. Where would it end!
    So yes, I do often exit early. I don’t usually hang on for the last $0.05 or $0.10.
    Noting your comments above, I now intend to exit earlier. My initial idea is to buy back the options for 25% of the premium received (e.g. sell for $1.00, buy back for $0.25). As you point out, this represents a reduction in risk.
    In addition to this I also intend to spend some of the premium taken in, to purchase insurance by buying some puts.
    I am undecided whether to buy further OOM puts to essentially convert my nakeds into spreads (as per Martin P. above), or buy a smaller number of puts nearer the market which would be equivalent to ratio spreads. It seems the latter option might tie in better with buying back the options earlier – there may still be a small amount of value left in the long puts.
    Your views on these points would be appreciated.

  5. Bill Luby 12/02/2010 at 8:13 AM #

    Superb post and comments.

  6. Mark Wolfinger 12/02/2010 at 1:45 PM #

    Martin P,
    I like the suggestion, in theory I like the limited losses. I never worry about commissions – if any trader does, he is using the wrong broker.
    But, I must ask: In real world terms, it is practical?
    If he sells a put, collecting $1, do you think that the put 3 strikes lower will cost only 25 cents? Maybe you are right, but with the volatility skew in place – rising implied volatility as the strike price moves lower – my guess is that those puts would be 30 cents bid with a 60 cent offer. Just a guess.
    I doubt this protective option can be bought at a price that is worth paying. Once puts get to a low price, they don’t drop much lower very quickly. There are always buyers for far OTM puts at cheap cash prices.
    Regards to you

  7. Mark Wolfinger 12/02/2010 at 1:48 PM #

    I appreciate the comment. It seems to me that the best compromise is to cut size in half.
    However, Steve is used to collecting enough income to meet his needs from this play. As long as he considers it to be ‘quite conservative,’ it is going to be difficult for hi to back off.
    When anyone finds a winning strategy, it takes a lot of convincing to give it up.

  8. Mark Wolfinger 12/02/2010 at 1:51 PM #

    I don’t believe that is correct.
    They were engaged in arbitrage – long some sort of bonds while shorting another. The spread between them kept increasing. Instead of recognizing they were wrong, they continued to add to their positions until it blew up in their faces.
    At least that’s what I remember. I did not take the time read it, but here is a reference.

  9. Mark Wolfinger 12/02/2010 at 2:05 PM #

    Here is the problem.
    It’s your mindset: “As with almost all my losers SO FAR, if I had hung in, I would have made my $1.00 (the SPX never reached 1000)…”
    It does not matter whether SPX reaches 1000. In fact, that is 100% irrelevant and it saddens me that you mention it or even think abut it.
    Your goal is to protect your assets.
    What would have happened to your account had SPX reached 1050 and IV had doubled and was continuing to expand?
    That’s the question. It has nothing to do with where SPX is headed. It only matters where it is right now (as danger strikes). If your account suffered a big loss – yes, it’s a ‘paper loss’ – your broker would have issued a margin call and you would ave been forced to buy in those puts at the ask price with the very high IV.
    That’s the mindset you need. You never want to reach that situation. So that’s why you covered early and continue to do so. It does not matter whether covering was a winning or losing move based on what happened after the trade.
    Most traders cannot get that point – or they disagree.
    You cover because prudence dictates that you must. You cannot take the risk of seeing what happens next. Thus, what happens next is of no importance – unless you still have big risk and only covered a portion of it.
    You have a decent next egg – especially if you are a youngster. Don’t blow it by taking more risk than you can accept.
    If you want to continue selling naked index puts, please discover how many are appropriate to sell by looking at risk graphs and estimating how bad it can get. That’s the best advice I can give you – other than to say: cease and desist.
    Of your choices, I prefer Martin’s approach ONLY when you are short too many puts for your portfolio value OR when you want to survive a Black Swan event. But, if you are trading a reasonably sized portfolio, then I prefer to buy fewer, CTM puts.
    Note: this will be the wrong decision in case there is a Black Swan event, but it will be helpful more often otherwise.
    The problem with buying OOM puts is that you will then not feel the need to cover your shorts when they decline to your buy-in price.
    However, I prefer covering your shorts as the best safety strategy.

  10. Mark Wolfinger 12/02/2010 at 2:06 PM #

    Bill L
    Many thanks.

  11. Steve 12/02/2010 at 2:20 PM #

    You are correct re. the premiums available. Here’s a snapshot for Jan 2011 Puts (all mid prices).
    Jan 570 P $1.05
    Jan 540 P $0.60
    Jan 500 P $0.40
    Jan 470 P $0.25
    So 100 points difference to retain 75% of short premium – not too much insurance there!
    Going the other way we have:
    Jan 600 P $1.80
    So, I’d have to sell 7 of the 570P at $1.05 to get $7.35.
    Take 25% o0f that premium($1.80) and buy 1 600P.
    Again, a 7:1 ratio doesn’t sound too hot!

  12. Mark Wolfinger 12/02/2010 at 2:30 PM #

    If you go with your plan, just cover at the appropriate price (ignore time).
    That will help – but it does leave you exposed to a potential big loss.

  13. Andy 12/02/2010 at 6:22 PM #

    Cheery reading. Very entertaining post.
    I have a dilemma that I am a bit confused at the moment with how to handle. Back in July, I bought 25 Jan 29 calls on VXX as a hedge. At some point, I shorted 25 Jan VXX 36 calls, effectively leaving me with a 29/36 bull call spread. During the last couple months, VXX collapsed on itself and ended up pulling a 4-1 reverse split. I understand my deliverable is now only 25 contracts upon exercise. What I’m having trouble understanding is everything else. VXX is trading at the post-split price of about 43. So does this mean if I hold until expiration and both the 29 longs and 36 shorts are in the money, the following occurs: 36 call is automatically exercised and establishes a short position of 25 shares, netting me 900. 29 call is also automatically exercised and I buy 25 shares @ 29 apiece, costing 725. I’m netting 175 per spread under that scenario, all this assuming both are considered in-the-money.
    Alternatively, is anything stopping me from buying back the shorts (trading at about .05 apiece), exercising the long calls @ 29, taking ownership of the 25 shares and flipping them back onto the market (assuming the current $43 market price and the $29 strike price, I net $14 per share. 14 net times the 25 deliverable is $350. Doing that for all 25 calls (350 times 25) is a net of 8750. Usually, I would just sell the option, but the premium is minimal and not even reflective of 25 shares (.03 or so on both the long and shorts…obviously VXX is worth more than that!), so exercise + sale seems to make sense here.
    I imagine I am not the only one wondering this, given the high volume of VXX options traded. I feel as if I should have exited the spread prior to the reverse split due to the uncertainty, but both situations would appear to be easy money (not taking the initial cost and commissions into account), so I’m wondering if these are actually viable for my 29/36 positon.
    Any help is greatly appreciated.
    Thank you!

  14. Mark Wolfinger 12/02/2010 at 10:15 PM #

    Hey Andy,
    Regarding the deliverable: “As a result of the reverse stock split, each VXX Share will be converted into the right to receive .25 (New) iPath S&P 500 VIX Short-Term Futures ETN
    The first thing you have to know is that these options are both VERY far OTM and are essentially worthless.
    Here is something that you must understand: When you are not sure what is going on, assume that everyone else does know. If these options were as valuable as you believe they are, they would not be trading at $0.05. They are trading at that price because the Jan 29 call will not be in the money unless VXX is 4*29 (116) or higher.
    If you exercsie the long calls, paying $29, you do indeed get 25 shares worth about 43. BUT NOTE: Pre-split, you had the right to pay 100x the strike price, or $2,900 for 100 shares. Due to the split, you have the right to pay THE SAME $2,900 FOR 25 SHARES. That would be a huge mistake.
    If you don’t get this, ask again, but to restate, here is what happened:
    1) The deliverable has changed from 100 shares to 25
    2) The price that a call owner must pay upon exercsie DID NOT CHANGE. It is still 100 * strike price.
    DO NOT EXERCISE. These options are worthless. Your spread was the 29/36. In today’s post split world, it’s the equivalent of the 116/144 call spread. Clearly very far OTM.
    And that’s what you should expect. You own calls, VXX has been dropping. How can the calls suddenly be in the money? They cannot.

  15. Fran 12/03/2010 at 12:39 PM #

    A Nightmare on Wolfinger Street, lol.
    Tonight I’ll dream with koreans and their issues.
    Thanks for sharing your experience. Great post again.

  16. Mark Wolfinger 12/03/2010 at 12:52 PM #

    Thanks Fran.

  17. Andy 12/03/2010 at 6:19 PM #

    Okay, I get it. There are multiple explanations online for reverse splits and options, but none quite as precise or useful as that. I was still thinking in terms of 25 times 29, not 100 times 29 (and as only a closing transaction)
    Ironically, now I’m afraid to hold these until expiration and let them expire worthless…Someone who doesn’t understand them may exercise and I’d be on the hook to sell 25 shares at $36 apiece (a short position for me). If my 29 calls expire worthless, I’m on the hook to cover at market price. Yuck. Think I’ll hold until near expiration, hope I can lure out an assignment or two, then close.

  18. Mark Wolfinger 12/03/2010 at 7:36 PM #

    If anyone exercises (you should be so lucky), yes, you will have to sell 25 shares. But you receive $3,600.
    You deliver the deliverable, or 25 shares.
    The exerciser pays 100 * strike, or $3,600.
    You have nothing to fear.

  19. Dauddy Bahar 12/05/2010 at 12:03 AM #

    Could you kindly elaborate on definition and the difference between Porfolio Margin vs Reg T margin? Thank you for your time.
    Dauddy Bahar

  20. Mark Wolfinger 12/05/2010 at 10:08 AM #

    Your broker is the best place to get that information, just in case they have a different requirement.
    But here is how I remember it (I am not researching it, but replying from memory): I’ll reply tomorrow in a blog post

  21. DB 12/05/2010 at 7:04 PM #

    Thank you Mark

  22. Hai 03/31/2012 at 4:18 AM #

    Very enlightening discussion. I too am going down the path of deep otm puts/calls

  23. Frank 03/08/2013 at 1:22 PM #

    Anyone care to update about selling naked OTM puts in 2013. The past 1-1/2 year has been nothng but up. It does not matter how you do it, you have a 100% win!!

  24. Frank 05/03/2013 at 6:07 AM #

    What about the weeklies (naked puts and calls). The time span is very short and if you are more conservative, you can skip the weekends and start on Monday and bet on about 4 days. You can still get about 10% return with very little risk.

    Hi Frank, this is an excellent question. I posting the reply as a blog post so more readers will see it.

  25. wild dreams 04/23/2014 at 7:36 AM #

    Interesting discussion on selling options and glad I found this blog! Selling naked without any exit plans or adjustment techniques can prove to be suicidal. Trade with care 🙂