Generally speaking, a seller of naked puts is looking to supplement income via a stock they are willing to own at a lower level. If you are not willing to take delivery, it is probably better to sell a vertical spread so that there is a built in stop out. Here I'm speaking of transactions of a reasonable premium amount, not 5 or 10 cents.
While it is true that the upside is unlimited against a naked call (and the downside is 0 on a naked put), naked puts suffer from systemic risk that calls for all intents do not. Both are subject to news/events specific to the company in question, but the risk of the short call running away from you because the market had a +20% day are well, fleeting. On the other hand, unexpected economic news, politcal/military events, liquidity issues, etc can tank the entire market 10, 20, 30% and have numerous times. A rise of similar magnitude, to my knowledge, has only happened after market crashes (so you would then be alert to the upside risk).
What? If the stock goes lower than the strike price, the downside on a naked put is the difference between strike price and market price. You will be forced to take delivery of the stock at the strike price when you could have bought it for market price if you hadn't written the option.
This is why skew exists, and should not deter anyone. The vast majority of people should buy a 20-30% dip, and so the fact that 99% of the time you're not going to be assigned means that it's a good idea in most scenarios.
I suggest most retail to be short straddles against a core underlying position for yield enhancement. Yes, over a number of decades you will have something go against you, but under the current monetary and fiscal regimes, you should be hoping for the day that you can buy the dip or sell the rip via a systemic short vol overlay.
The problem with traditional retail being short naked puts is they generally do not have a pool of cash sitting on the sidelines to absorb margin calls and/or buy (if assigned). Likewise, buying in a tanking market on margin entails additional risk that needs to be well considered before hand.
Selling straddles or strangles against a long position in a stock that you do like is reasonable play, but there needs to be a full understanding of how vol and time decay can effect the value of the entire position up to maturity and a recognition that nobody is getting assigned/called early excepting unique circumstances (ie, high dividend stocks)
For those reasons, I'd only suggest these types of trades to fairly well capitalized retail investors and those who have taken the time to gain a basic understanding of equity options and the use of margin. In proper hands, these can be very rewarding trade ideas/techniques.
> The vast majority of people should buy a 20-30% dip, and so the fact that 99% of the time you're not going to be assigned means that it's a good idea in most scenarios.
So "people should buy a 20-30% dip" but should not be invested already? Because if they are, selling puts may not be a good idea.
I think what he is suggesting is that historically buying after a 20% or more sell-off leads to outsized gains in the US market.
That does not preculde already being invested as sitting on the sidelines waiting for such a move can be self defeating (the market rises 50% then drops 30% dramatically you would still be better off to have bought day one).
If you sell puts and are assigned, it may or may not happen at the optimal post crash price, but you will still be adding to your long at a much lower level. For instance, you sell a 30 put when the market is at 45. There is a great sell off, you are assigned when the underlying is trading at 25. You own at 30 less whatever premium you received, likely above 25. Certainly not the end of the world, but investor psychology is such that some people will be upset after the fact if they are paying more than current market price.
However, if you are not assigned you'll be pocketing those premiums as added income. But that is also another risk with naked puts - the market sells off but well before expiration and then rises again. You would miss the chance to buy unless you make the decision to take back the short puts at a loss and buy the cash at the now lower price. Again, you'll likely be paying net more than just having parked the cash and waited.
So naked puts may not be the best strategy if you know you absolutely positively will want to buy at a certain price, no matter what.
The point is that if you're already fully invested you don't have money to buy those additional shares. And if you didn't want the leverage before, commiting to take on leverage later may or may not be a wise thing to do.
It may make sense if you had dry powder waiting for a correction. But at that point you are forced to buy (and as you say it may be at a higher price that the prevailing one in the market). You get premiums but you lose flexibility.
> Generally speaking, a seller of naked puts is looking to supplement income via a stock they are willing to own at a lower level.
The problem is that they may be willing to own at a lower level today. But it may happen that when they have to own it the price is lower for a good reason.
While it is true that the upside is unlimited against a naked call (and the downside is 0 on a naked put), naked puts suffer from systemic risk that calls for all intents do not. Both are subject to news/events specific to the company in question, but the risk of the short call running away from you because the market had a +20% day are well, fleeting. On the other hand, unexpected economic news, politcal/military events, liquidity issues, etc can tank the entire market 10, 20, 30% and have numerous times. A rise of similar magnitude, to my knowledge, has only happened after market crashes (so you would then be alert to the upside risk).