How an options seller deals with a crash

When the market is crashing, it’s tempting for an options seller to panic and throw a huge short position on, perhaps even buying puts. Some folks end up making money and I’m not going to knock them at all.

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But I’ve been there, done that, many times, and I’m not going to do it again. I always got killed by a bounce—every time. The odds of the market continuing to crash day after day, without a relief rally, are slimmer than one would think.

So what is an options seller to do when the S&P falls 10 percent?

First, use the event as one of the most valuable learning opportunities you can find. Seriously, it’s a golden opportunity. How did your trading plan react to this move? Are there things that would have reduced risk without greatly dragging down your profits?

I will put forth that my plan is handling the situation well, though I didn’t always have a solid plan in the past. Many of the parameters that saved me from a lot of pain these past weeks are things that I am usually teased about.

First of all, I do stay way the heck out of the money. After this massive drop, only one of my 23 positions actually went “in the money.” That’s pretty impressive when I think about it.

As many of you know, I am only able to stay so far out of the money and collect a decent credit by selling options 150 days from expiration. Most people would never consider selling that far out; years ago I wouldn’t have either. But hard earned battle scars can change you.

Also, I do employ tight stop losses (2x credit received or option strike breached) so that no position remains sitting in a dangerous spot where a big drop can really demolish it without warning. While backtests tend to frown on such stop losses, I defend positions aggressively with the sole purpose of avoiding my stop loss—which is something backtesting does not simulate.

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So, learning this wisdom is all good, but what can be done now?

In times like this, other traders often jest: “You wanted volatility for premium selling, well here it is.”

Yes, premium is now high which is great for selling. But those positions we had put on before; we still have to deal with them. They can still hurt. So it takes time, at least a month, for the richer premium to really penetrate the portfolio and start paying off.

In the meantime, patience is key. The existing positions are to be defended mechanically until they either come back to profitability or hit their stop loss. Either way, it’s all part of the plan.

We also stay focused on the big picture and continue to put probabilities on our side.

Trade well!

J. Arthur

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7 comments on “How an options seller deals with a crash

  1. Interesting, I’ve looked at further out options and it seems like the risk profile is worse
    For example, 235 spy put
    Expiry 3/29 – 9.30 in premium
    Expires 1/28 – 5.30 in premium

    Looking at theo pricing, if SPY moves -5/+5
    PnL for 3/29 option: -213/+185
    PnL for 1/28 option: -130/+240

    The risk profile looks better for 30 DTE put.

    I was buying some puts to manage deltas when the portfolio was getting too long. Then market would bounced and I would convert it to a put spread… Wait some time, usually 1, rarely couple days and close short leg when it offset the price of long. Next day or two market drops, long put is green again and I close it.
    The moves were so fast that this worked.

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    • I think it depends on how you define the risk profile. I don’t go further out in time so I can collect more premium, I go out further in time so I can be further out of the money and still collect premium. Plus, fear is more overstated further out in time. But even that risk profile can look less appealing on paper. I judge by “in practice” where there are a lot of advantages to my selection—such as more room to defend. And in this recent crash I am thankful I sold at 10 deltas and not 16—or I’d be in the money where gamma doesn’t care what your risk profile was.

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  2. Hello. If i already have bought a 245 C Jan and 250 C Jan on Dow, can i consider these buys as a protection if i want to sell 250 C Mar? Please answer, i am trying to find out a way how to profit from this fall :/

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  3. Arthur – any thoughts on how much delta, theta and vega you have historically carried relative to your net liq? Obviously, different market conditions will impact these numbers at any point in time but I am curious what you have averaged trading your strategy over the long haul. I know on TT they have talked about a theta target of .3% to .5% of net liq. while keeping notional around 3x net liq. Also, do you look at your notional outstanding relative to net liq when measuring risk? What about total credit collected/outstanding compared to net liq and how do you think about this relative to monthly/annual portfolio returns that you target?

    I am fanatical about tracking my weekly portfolio stats in a number of different ways. I have been trading for 20 years and have focused on option selling for about the last 10. I have had my fair share of expensive lessons over the years and after reading your blog and trading plan I started to reflect on my trading style. I have found my most successful years were when I primarily sold options farther OTM and expirations 90-180 days out. From a psychological standpoint, I feel more comfortable knowing I have plenty of cushion to my strikes and time to adjust. It allows me to be more patient and the swings are typically not as violent.

    As an FYI, here are a few things I have done a bit different in comparison to your strategy:
    – I will trade individual company stocks but will keep trade size much smaller relative to index/ETF positions
    – I am using 3x total credit as my stop/risk tolerance but will continue to analyze this in different market conditions
    – I also use 50% as my target profit
    – I will open positions with anywhere from 90 – 150 DTE
    – I will typically leg into a full position in order to diversify strikes; in weeks like what we just had it has allowed me to continue to add with spikes in IV and receive a nice credit going further OTM
    – I am still reviewing how quickly to make adjustments; I like your plan and thought process on adjustments, but if a trade moves against me I am not only looking at delta but I am also considering where my net P&L is at the time and if the stock is at key support/resistance levels before I adjust. I will also consider my overall delta for the position if I have multiple positions in the same underlying.

    Keep up the good work and thanks for continuing to share. If interested would love to trade notes sometime.

    Regards,
    Russ

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    • Russ, thank you for the comment! A lot of good stuff in there and I don’t have a lot of time right now to respond to it all. I will say that I have gone back and forth between a stop loss of 3x total credit received and 2x. Right now, I’m pretty set on 2x. The backtesting I’ve done does favor 3x, however, that backtesting does not take into account my trade defense mechanics which strive to make it a lot harder for a position to hit the 2x loss threshold. All in all, I feel better about looking at all of my positions and knowing that I don’t plan to take a loss any greater than 2x that credit. Personal psychology is an aspect of a trading plan that I don’t think be overlooked.

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