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TheStreet Open House

Puts: The 'Short' History -- Part 2

Stocks in this article: VIX

The year was 1990. I was in New York, invited to hear and see a speaker who was going to explain to stock exchange professional options traders why his firm had recently decided to disallow the selling of naked puts. That's right, if you were a customer of this large well-known brokerage firm, you were no longer allowed to short sell naked puts. Prior to that decision, especially throughout the rocking and rolling (upward) 1980s (well, from August of 1982 to October of 1987) you could short puts "til your head caved in" or until you ran out of margin capital. Those naked put short sellers as a collective group did quite well, that is until the crash of 1987 and the mostly forgotten (not by me!) mini-crash of 1989.

One quite bewildering outcome of this major decision by this brokerage firm as well as many other brokers who played piggyback by killing shorting naked puts was that since that time, an entire generation it seems has been trading options not having any clue that a put sold short it totally equal to a buy/write! During the 1980s, almost everyone trading puts knew that fact! Today, I would bet that not one in 50 know this fact to be true!

Things change, don't they. And change they did for those who sold puts naked. Why just this year I have once again watched far too many folks use this very nasty, fickle form of options trading blow up their capital balance accounts, maybe some finding that shorting puts can be truly as dangerous as picking up nickels in front of a bulldozer! If I could only have teleported all of them back to the day when I heard and watched that speaker do his "splainin" as to why his brokerage firm forbade naked put shorting!

(Almost a month ago, I wrote an article entitled Puts: The 'Short' History. You might want to either read it for the first time or re-read it before moving on with part 2, for continuity purposes that is.). The enticing element to naked put selling/shorting is the "getting something for nothing" mentality that appeals to so many of us. Those who do eventually adopt this style of options trading must also adopt an attitude of either that of an "ostrich with its head in the sand" or start with plenty of capital and not a care about losing it and plenty more where that came from! And be prepared for incoming long stock in your portfolio to possibly multiply like rabbits.

Most inexperienced naked short sellers see a big premium, and think "man there's no way this stock is going down to that price, not in this market or any market!" Well, that is red flag numero uno for any risk manager watching this person's portfolio! Red flag numero dos is when that same person, after seeing things move along a bit their way begin to aggressively raise their size because they adopt an attitude that has them thinking "hey, this is like printing money!" Red flag numero tres is when this type of trader personality begins to double up after getting "slammed" the first time around, he/she thinking they know where the bottom price for that stock is! Ya, good luck.

Do yourself a huge favor and learn to realize that a put sold short is totally equal in all respects to a buy/write. The only difference is that a buy/write invites two commissions and the put sold short costs just one commission. All profits and loses no matter where the underlying stock might go and/or expire will alter that fact. Thus, do NOT buy/write unless you are handcuffed by the current crop of brokers and firms today who STILL forbid anyone to sell puts short but STILL allow for their customers to buy/write. A buy/write is a put sold short via the synthetic route and it is NOTHING more than that!

Do not waste your time and energy attending seminars if the speaker/guru does not know this fact! Stop the ignorance before it begins What a concept?! Why the next thing we might find is that folks might come to realize is that an "iron condor" is a fancy term for what is just a combination of two spreads.

Ok, so if you do now know or had already known that a buy/write is a put sold short, then you have to know that any calls sold against long stock creates that same synthetic situation! Thus, if you are tempted for whatever reason (greed or fear!) to sell any calls on your long stock in order to generate additional income (that's what this ad said about some upcoming seminar on options trading they are offering for FREE!), for "Pete's sake" as well as your own, simply stop staying long that stock and sell it! Then immediately sell the corresponding put short. BINGO! I just saved you commissions and the risk/reward is totally the same if you had held that stock long and sold the corresponding equivalent call short! And that advice was also FREE, but I saved you the energy burned finding that out.

Every R.O.T. (Registered Options Trader) knows these facts and principles. Every one of them hopes that all of you remain both ignorant of them as well as continuing to trade options! Every R.O.T. I know and knew prefers that your skill set as per the options world never comes close to understanding these basic principles of options because each and every R.O.T at work knows that the more ignorant you are the more they have the edge! For them, your ignorance begets their bliss, as well as their next BMW.

I am here to tell you that you should, if not must, rise above the ignorance! However, in order to do so you must be willing and able to learn. Once you do learn the basics of options trading, you will be far ahead of the remaining 90%, or so, (my guesstimate!) who continue to trade options and continue to remain clueless. That is one bad combination! Strive to learn and to become one of the 10%! The more you know about options, the less edge the professionals have and the wiser you will be.

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