When I get some time, I'll respond in a manner more fitting to your very thorough post. For now a very quick reply...
Reducing the amount of up-front capital does not increase your ROI with an equivalent risk/reward profile. Just ask anyone who has used margin. (Margin poses two problems: required interest payments and increased risk).
The use of margin in writing puts incurs no interest payment. That's because you are not carrying a margin balance (as you would be with CCs on margin). You're simply tying up margin buying power. Because of this you actually get to COLLECT interest on your cash collateral, increasing your returns. Barring the rare substantial gap down, sold puts can usually be bought back if necessary before an actual margin debt is incurred. Discipline is the key.
Think of it this way. I'm going to offer you the following bet: Give me $1, and flip an honest coin. If it's heads, I'll give you $1.50. If it's tails, I'll give you $.75. You can do this once a year. The "expected return" of this strategy, as typically calculated, is (.50 + -.25)/2 = 12.5%.
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You have another option. You can make the above bet with only 50% down. So you give me $1, and flip an honest coin. If it's heads, I'll give you $2. If it's tails, I'll give you $.50... The "expected return" of this strategy is (1 + -.5) / 2 = 25%.
The second game here is not quite the same as the first game with 50% down. The first game with 50% down is one in which I give you $0.50 instead of $1.00, and if I win I get $1.50 and if you win I get $0.75. I'll take that bet every time! :)
Regardless, in the long run (asymptotically), it appears to me that both games are profitable (assuming we never run out of money with which to place the bet), since the expected returns are positive. This leads me to believe that we are not both talking about the same thing and so we should spend some time clarifying.
The real danger inherent in these games is of losing several times in a row and having $0 with which to make the next bet. In fact, this is expected to happen at some point. For example, if I lose the first 4 tosses in the first game, I am done. In the second game, it only takes losing the first 2 tosses to wipe me out. I think this is what you were getting at?
More later...
dM |
