As a newbie to options I have a basic question that hopefully will keep me from getting blown up. I was asked to invest in a put writting strategy on index options. The strategy will write naked puts (EUROPEAN) in nasadq, oex. The "pitch" was that writing puts is a better way to invest in the index than going long the index. The returns streams seems to back this up but I was hoping for some more informed feedback. I guess I'm looking for the hidden, or obvious pitfalls. thanks

Sell 5 delta puts, in huge amounts... also known as selling curve...

Nodd:You need to find out more about the strategy; in particular, what will be the rebalancing policy? You can lose a lot of money in not very much time writing naked puts -- does the strategy essentially assume market stability, and hold onto positions that have lost money in anticipation of recovery (increasing risk); or does it continually rebalance to a particular market exposure, effectively cashing in gains and losses as they occur? Also, how much attention is paid to tax consequences? And what kind of puts are to be written: distantly out-of-the-money, near-the-money, or in-the-money?There aren't necessarily right and wrong answers about what's best to do, but you should at least make sure you know what is planned (and something should be planned!) for particular outcomes, so that you're not clamoring to disengage while the fund manager is stepping hard on the gas pedal, or vice versa, and so that you understand in what circumstances you'll lose money, and how much.

"The strategy will write naked puts"Tick ... tick ... tick .. BOOM!That's the sound of an investor writing naked puts. This strategy is equivalent to buying more and more futures as the market goes down. The returns from this strategy are fine during periods in which the market is going up or is going sideways. But it will only take one down market to result in BOOM!

To add to Johnny's point,You may want to try looking for info on Victor Niederhoffer (my apologies if i have spelt it incorrectly). He was following a similar strategy on the S&P 500 when a violent downturn wiped out his fund.

And also,"The "pitch" was that writing puts is a better way to invest in the index than going long the index." Does he mean, naked or covered puts?This would make sense for a non-naked (covered), out-of-the-money put position. For example, if the Mar 03, future contract is trading at 939 (939 market price today), and you sell the Mar 03, 850 strike put, for let's say 28.2. You have basically bought the long position for 821.8. Now, this is leaves a lot of margin for error. The S&P would have come down by 118.2 points, a very large down move, for you to hit your break-even point.However, some of the conditions that would only be better than an outright long position are, if you are satisfied with making 28.2/850 = 3.3%, as opposed to however high the long position would go, if your "put limit" never catches (S&P stays above 850). If you take the covering capital, that would have gone towards the outright long position and put that in some highly liquid fixed-income vehicle, ready to be converted to cash in case the S&P nears 850, that would increase yield. And finally, you have to have firm determination in the "put limit" that you create, because if some crazy event makes the S&P drop, you are stuck, unless you want to buy the put back for some higher premium (take a loss). Time is a very important consideration.

Oh, come on Johnny! Dangerous? Sure. Inevitably destructive? No. Writing puts is most comparable to buying stocks on margin, which many people have done and lived to tell of. Sure, you can be stupid about it, but most things can kill you if you're stupid enough with them. To my thinking, the strategies that people write off as being too dangerous are the ones that hold the best possibility for offering advantage.

>> Tick ... tick ... tick .. BOOM!A very apt metaphor. The tantalizing thing is, each 'tick' likely represents outrageous positive returns -- this fund will look like a huge winner on paper. Read Taleb's Dynamic Hedging if you don't see why. If the short puts are being hedged with NDX futures, take a close look at the volatility exposure of the fund. Vols were down late last year and early this year in US equity markets, so a short vol fund will naturally look attractive. But if the puts are really being sold unhedged, then run -- don't walk -- away from this strategy.

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Also, even delta-neutral positions are not safe. If the puts have high gamma, that can also leave you unhedged, and wipe you out. So if you are going to sell naked puts, go for the lowest delta, and lowest gamma, with acceptable returns.

MarsdenI'm sure you lead a charmed life in which you can sell puts for years on end without mis-hap; you would stop just before a crash or bear market and use your winnings to buy a tropical island - or a racehorse that would win you even more money. But most of us mere mortals have a finite amount of luck ... the strategy of selling puts would be fine for a while and then would end in disaster. This is the law of Tyche and her sister Nemesis.Selling puts is not "most comparable" to buying stocks on margin. Buying stocks with borrowed money is "most comparable" to buying a forward contract: the profit on the upside is the same as the loss on the downside. This is not true of selling puts, where the profit on the upside is limited to the put premium, whereas the loss on the downside is limited only by the strike price.There's a story that used to do the rounds at the end of the 1980's about a young trainee accountant, who would then have been earning about £8,000 a year salary. He decided to supplement his income by selling puts, which worked fabulously all through 1986 and most of 1987 until ... BOOM! The 1987 crash resulted in him owing in excess of £1 million.

I think I will change my name from "FDAXHunter" to "ODAXCurveSeller"...

QuoteOriginally posted by: JohnnyMarsdenI'm sure you lead a charmed life in which you can sell puts for years on end without mis-hap; you would stop just before a crash or bear market and use your winnings to buy a tropical island - or a racehorse that would win you even more money. But most of us mere mortals have a finite amount of luck ... the strategy of selling puts would be fine for a while and then would end in disaster. This is the law of Tyche and her sister Nemesis.There's a story that used to do the rounds at the end of the 1980's about a young trainee accountant, who would then have been earning about £8,000 a year salary. He decided to supplement his income by selling puts, which worked fabulously all through 1986 and most of 1987 until ... BOOM! The 1987 crash resulted in him owing in excess of £1 million.Two sayings (peoples' wisdom) for the two aforementioned paragraphs respectively.1) Its not every day St John's day!The Irish of this forum may replace St John with St Patric.Tyche and Nemesis are two cute twins but they have a drawback. You cant pick em up, they pick you up! And rarely you know who is who!! 2) You cant get anything from someone that owns nothing!Someone should have checked out this lad's creditworthiness (Broker, counterparty, etc.). This lad took advantage of the greatest device of the western capitalism, the institution that is called limited liability.RegardsAnthis

I can't believe we are discussing the "pros" and cons of selling downside puts.... I thought this was a practitioners forum... well, practice away... If you want to sell curve, PM me... I can always accomodate, especially the tinys, preferable on ODAX and OESX and SPX, but if you want to sell FTSE or NDX, we can arrange something... Remember, Remember the the 16th of September.Regards.

I guess there's no good reason for me to try to dissuade anyone from thinking that naked puts are unsafe at any price, so I'll sign off.