Just an additional observation to your example.
When you sell a naked put, you sell it at a particular price, but you also sell it at a particular volatility. IMO, it's inappropriate to sell puts if you don't understand how their volatility affects their pricing. Any good book on options will cover the concept in sufficient detail.
If a sudden drop occurred in the price of the stock and took it down 40 points from 70 to 30, the increase in volatility of the put you sold would be explosive. That increase would affect the put pricing dramatically. While it is true that at the moment of expiration, expiration, a put that is 40 points in the money would likely be priced at 40, after a tumble in the price of your stock, volatility could easily jump 50% or more, pricing your put much, much higher.
How this affects the sale of naked puts is notable. Experienced options traders try to sell option contracts priced at high volatilities and repurchase them at lower volatilities or let them expire. The opposite may occur in the example you offered. You've sold what you properly believe is high volatility, but then things happen that are totally beyond your control, the stock tanks, and you are forced to buy the put back at a much higher volatility. In a zero sum game, that means you lose.
Thank you for the quality and the educational nature of your post. Information like the example you provided serves to increase the knowledge of all CMGI threaders.
Mark A. Peterson |
