Selling Naked Puts In Current Environment

During my recent trilogy on the put-write strategy, my intent was to identify an approach that performs well in a non-trending market. While I still believe we are stuck in a range defined by about 820-980 on the S&P 500 index (^GSPC), a strategy that involves selling puts generally performs at maximum levels toward the bottom of a well-defined trading range. In short, the current situation looks like an excellent time to write some cash-secured puts.

Several factors indicate that the timing for put sales may be ideal right now. With the VIX (^VIX) up over 51 once again as the market opens this morning and most measures of short-term historical volatility (such as the 10 day HV in the chart below) showing that the VIX is well above actual volatility we have experienced during the past few weeks, a likely conclusion is that volatility is overpriced at current levels. Further, with the SPX right at 830 as I type this, we are near the bottom of the trading range in the SPX, with significant support likely to be found in the 820-830 range.

Finally, the news flow has been so negative lately, from financials to retailers to Steve Jobs to global trade, etc. that a larger fear and anxiety component is starting to creep into implied volatility measures like the VIX.

For those looking to limit risk, cash-secured puts on indices or ETFs covering a group of stocks can help to eliminate single stock down side risk. Those who are interested in limiting risk from writing puts may prefer to look at a bull put spread, where the writer sells a put near the money and buys another out of the money put to limit losses.

[source: VIX and More]

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