Guest Columnist at The Striking Price for Barron’s: The Case for Options Trading

Once again I am delighted to have an opportunity to serve as a guest columnist for The Striking Price on behalf of Steven Sears at Barron’s. While the title of the column is The Case for Options Trading, the focus of the article tilts in the direction of selling options and lists some of the reasons why new and relatively inexperienced options traders should invest some of their time during the coming year to learn more about selling puts and calls – and not just defined risk positions, but naked (uncovered) options as well.

The Barron’s article lays out some of the rationale behind my thinking, but this is a topic I plan to return to on a regular basis that dovetails with some related subjects I have been discussing in this space and are highlighted in the links below.

Related posts:

• The Case for Selling Apple Puts
• Can Selling Options Make You a Better Trader?
• The Often Overlooked Put Writing Strategy
• Graphical Comparison of Performance of PutWrite and BuyWrite Indices
• More on PUT Returns
• Selling VIX Puts with the Help of a Put Matrix
• VIX Put Matrix Offers Glimpse of Expected Future
• Selling Naked Puts in the Current Environment
• Post-Geithner Financial Naked Calls

A full list of my Barron’s contributions:

• The Case for Options Trading (January 2, 2013)
• Calm Down and Exploit Others’ Anxieties (November 14, 2012)
• How to Trade Options Around Volatile Events (July 10, 2012)
• Be Greedy While Others Are Fearful (May 3, 2012)
• Ways to Turn Volatility into an Asset Class (January 12, 2011)
• There’s Opportunity in Uncertainty (November 18, 2010)
• Will Market Volatility Return to Crisis Levels (September 15, 2010)
• The Perils of Predicting Volatility (May 20, 2010)
• Take a Longer View on Volatility (July 2, 2009)

Disclosure(s): none

Selling VIX Puts Pre-Expiration

Selling naked puts on the VIX just prior to expiration can be a surprisingly low risk volatility play.

Normally, selling naked puts is a dangerous strategy because of the risk that negative news can overwhelm the underlying, causing it to gap down and create a large loss. With the VIX, however, spikes are almost always upward, because while threats to equities are relatively easy to identify, it is much more difficult to discern when these threats are suddenly extinguished.

For this reason – and because the VIX has lately shown some reluctance to drop below the recent floor of 27 – selling a naked put on the VIX is a lot less risky than selling naked puts on other securities. Risk to the down side is definitely limited, yet the limitations are not perfectly mathematically quantifiable.

A sale of the June 30 put illustrates one potential naked put sale opportunity. The profit and loss chart below outlines what the trade looks like. With yesterday’s closing price of 30.81, the trade is profitable if the VIX rises, drifts sideways or loses up to 1.61 prior to tomorrow's special opening quotation. The gain is $80 per contract. The profit and loss chart shows that a loss of $170 per contract occurs at 27.50. Assuming 27.00 is a floor in the VIX, then the maximum loss is likely to be capped at $220. While a 12.3% drop in the VIX in one day cannot be ruled out, it is obviously not a very likely scenario.

Reminder: VIX options expire on Wednesdays. The June VIX options expire June 17^th this cycle. The last trading day for these options is today, Tuesday, June 16^rd. (See the 2009 options expiration calendar for more the full 2009 options expiration schedule.)

[source: optionsXpress]

Disclosure: Neutral position in VIX via options at time of writing.