Because I consider your question to be so important, I'm going to make just this one exception in my agreement to not post for the next two weeks given that I recently lost a bet involving that punishment.
Hotpanera2 also talked about ostensible huge risks given my large "notional value" of my naked put positions.; The fallacy though is that most of that notional value involves prices below which that stocks would never see even if the market lost a third from here in addition to the 8% already lost.
Take Pfizer for example where I have 50 naked puts short of the 20-strike expiring in Jan. 2014. The notional value there is 100K. But realistically, even in the worst of markets, can this stock really go much below a price like $16? I say it can't because at $16 a share, it would be selling at just 7 times next year's earnings expectations of about $2.30. Moreover, at just $16, the dividend yield would be a full SIX percent of the new, higher 96 cents a year that will be announced in just four weeks. With that payout only constituting 40% or so of earnings, there would be few worries that it couldn't be maintained. It would be a huge surprise if Pfizer were to fall to a price where the dividend yield would be even more than 6%. So the PE ratio and the dividend yield for me puts a floor on the stock of about $16 in virtually a worst-case situation.
If Pfizer indeed was to tumble into the high teens, margin considerations would force me to roll out. I could roll my 50 options with a 20 strike for Jan. 2014 out to something like 62 of the 16-strike naked puts out to Jan. 2015. While 16's aren't currently offered for that year, they would be offered if the stock were to go below $20.
Right now, the asked price of the 20's for Jan. 2014 are $106 per contract. The 15's for Jan. 2015 are bid at $72 while the 18's for Jan. 2015 are fetching $138 bid. So if there were 16's being offered, they would now be selling for about $94 on the bid.
So in a terrible market, I'd trade my 50 Jan. 20 strikes out to Jan. 2014 for something like 62 of the super-safe 16 strikes out to Jan. 2015. By doing that, not only would I hold onto all of the original money put into the account but I would be putting in a little bit more on the rollout.
Of course if the stock was four points lower, the prices would change for each series but the relationship would be roughly the same.
The notional value of 62 naked puts with a strike of 16 is actually a tiny bit less than for 50 naked puts with a 20 strike. But should I be in the least concerned with a near 100K notional value for rolled-out 16-strike naked puts when it's almost inconceviable for the stock to fall much below $16 even in the worst of markets with $2.30 in earnings and a 96-cent annual dividend payment which nevertheless is still only about 40% of earnings?
So the real question isn't what the notional value of my holdings is - the real question is what is the notional value if the stock plummets to almost the worst price that is reasonable in a terrible market and can I roll my current holdings down to strikes that low without increasing the margin requirements.
And because I can do this in even the worst markets for all my holdings, I say that in the fullness of time, my real risk is neglibible. That doesn't at all mean that in the shorter term I can't have losses. Yes - I may have to book short-term losses - even in some cases substantial losses. But out a couple of years where time works for me, it's hard to lose.
As I mentioned earlier, I made an exception in responding to your post. But I don't want to be thought of as a welcher after having made a fair bet so in good conscience, I won't be able to further respond for the rest of the month if you should have any rebuttals to what I just said. If you do have rebuttals, please defer tham for two weeks and I will respond at that time.
Thanks for the thoughtful reply. I actually agree with your fundamental analysis. I think the concern with this type of strategy is that markets are not always rational. I'm reminded of funds like Long Term Capital Management that were able to leverage small profits into impressive annual returns... until prices fell beyond margin-safe levels. I hope you have considered whether these are risks you need to be taking. In any case, it makes for interesting reading. Good luck.