Unveiling the Truth: Naked Put vs. 112 Strategy in a Market Crash

If you’re an options trader, you’re likely well aware of the debates surrounding the riskiest strategies. Today, we’re taking a deep dive into the comparison between the notorious naked put and the intriguing 112 put front-ratio strategy, particularly in the tumultuous waters of a market crash. Brace yourself, because what we uncover may just challenge everything you thought you knew. Let’s delve in!

Naked Put Overview

Before we get into the nitty-gritty, let’s lay down the foundation. A naked put, also dubbed an uncovered put, is an options trade where the seller writes a put option without holding the underlying asset. Essentially, you’re granting someone else the right to sell you a stock at a predetermined price (the strike price) before the option expires. Sounds simple, right? Well, hold on to your hats because the risk profile of this strategy is anything but.

In essence, a naked put can yield profits in bullish, neutral, and even slightly bearish market conditions. However, as the underlying asset plunges, the losses can spiral indefinitely. The Greeks associated with the naked put—short Vega, short Vomma, and long Vanna—all spell trouble when volatility rises, as we’ll soon see.

112 Strategy Overview

Now, let’s shift our focus to the 112 Strategy. This involves a clever combination of options positions: buying one put option, selling one put option with a lower strike, and selling two out-of-the-money (OTM) put options. The aim? To craft a spread that thrives in neutral to bullish markets and potentially rakes in substantial profits if the underlying takes a downturn nearing expiration.

Similar to the naked put, the 112 Strategy carries short Vega, short Vomma, and long Vanna positions, which can wreak havoc during a volatility surge, such as in a market crash. However, with its 3:1 ratio of short puts to long puts, the 112 Strategy’s Greeks are turbocharged compared to its naked counterpart. Brace yourselves as we witness the impact during the Covid market crash.

Market Crash Simulation

Let’s paint a vivid picture of the risks at play by simulating a market crash scenario for both strategies. During such a crash, the naked put exposes the seller to unlimited risk, with losses compounding due to the volatile Greek structures. In contrast, the 112 Strategy, with its amplified Greeks, amplifies losses even further.

Surprisingly, while these strategies may appear comparable initially, the disparity in their Greek positions becomes glaringly evident when volatility spikes. The 112 Strategy ends up taking a whopping five times the hit compared to the naked put. In real terms, that translates to a staggering loss of $1.3 million for the 112 Strategy, dwarfing the $286,000 loss incurred by the naked put.

Comparing Risks

Let’s sum up the risks associated with each strategy. While the naked put boasts theoretically unlimited risk, the 112 Strategy, despite offering apparent downside protection, magnifies losses exponentially in a crash scenario. It’s a sobering realization that the 112 Strategy, often perceived as a safer alternative, can actually be five times as perilous as the already risky naked put.

Practical Considerations

When it comes down to decision time, there’s one crucial factor to weigh: the potential profit during the final days of the trade. The 112 Strategy may offer substantially higher gains if the underlying falters slightly near expiration. However, in neutral or bullish conditions, both strategies perform comparably. It’s during a severe crash that the 112 Strategy reveals its true colors, emerging as one of the riskiest options strategies in existence.

Closing Thoughts

So, which strategy aligns with your trading style and risk tolerance? Remember, each strategy carries its own set of pros and cons, and understanding these nuances is paramount. If you found this exploration insightful, show your support by liking this article and subscribing to our channel for more trading insights. Remember, knowledge is power in the world of options trading. Best of luck out there!