Risks and Tradeoffs in Selling Equity Puts
Summary
The document examines whether selling equity puts can provide a dependable business or outperform savings. It explains the basic compensation argument: put sellers accept downside exposure in exchange for option premium, reflecting demand for protection against market declines. The responses stress that this premium is not an easy or guaranteed return.
A viable approach would need explicit rules for the underlying, strike, expiry, entry and exit, and hedging. Hedging with the underlying or other options can reduce exposure, but it also costs money and may erode returns; transaction costs and the volatility smile can make protection especially expensive. The discussion points to market crashes as examples of the risk of large losses and notes that declines can be faster and sharper than gains. It offers no quantitative backtest or evidence that a particular put-selling strategy beats a savings account, and the claim that hedging is easy is challenged. The lesson is that option premiums alone do not establish an attractive risk-adjusted strategy.
Key ideas
- Put selling earns premiums in exchange for exposure to sharp market declines.
- A defined strategy must specify the underlying, strike, expiry, entry, exit, and hedge rules.
- Hedging can reduce losses but may consume much of the premium through option costs and trading friction.
- Large market drops can create losses that outweigh premiums collected during calmer periods.
- The document gives no systematic evidence that put selling reliably beats savings returns.
Tags
Full text
# Can selling put equity options be a good business? # Can selling put equity options be a good business? In one of his last books Jack D. Schwager suggested that selling equity puts can be a good business. The puts are like insurance policies against market downturns and there is a natural demand. Therefore, he who sells puts (w/o any directional bias) should expect to be compensated for bearing the risk. There is a chance of getting wiped out, but that risk can be hedged easily. Do you think an individual investor could do it and earn so much that it beats keeping the money in a savings account. ## Answer by Shahar (score 4) https://quant.stackexchange.com/a/14752 If by an individual investor you mean something like the average investor, then the answer is an unequivocal no: first of all, the average investor probably cannot sell put options. In order to sell put options, you have to be very experienced and climb up the option trading approval levels. Second of all, there is no such thing as risk that can be hedged easily - not if you want to keep the profits that you're going through all of this trouble to earn. And this brings me to my third point: what exactly would be this investor's strategy? How would she hedge the risk? Where exactly (i.e. at what price / time / conditions) would she write the options? And which options: on what security, at which strike price, at which expiration? When (again, under what conditions) would the trade be closed? Would the option be held till expiration, whether in or out of the money? I have no doubt that many option traders have good answers to these questions. However, with all due respect, I am not sure that the average investor even understands some of these questions. So no, for the average investor, selling put options without a game plan is not a good idea. ## Answer by berkorbay (score 1) https://quant.stackexchange.com/a/14753 It is the opposite of Taleb's advice. There is no single answer on that, but one could say you are exposing yourself to potentially deadly risk. I bet you did not want to be in that position in October 1987, dot-com bubble, during the latest crisis or any "Black" day. You can hedge that risk, but it also diminishes your return. You can hedge by either using the underlying or another option (bull/bear spread?). Given the volatility smile, the deeper out of money will have higher IV therefore comparatively be more expansive. Add the friction (transaction costs) and your strategy can be worthless. But true, given today's "risk-free rates" it will probably beat savings account for some time. Last word. Past data shows that increases in the asset value is more likely to be gradual but decreases are sudden and drastic.
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.