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My question is related to the exchange circuit breakers and “max loss.” Since the exchanges will halt trading if the market declines 20% in a day, wouldn’t that prevent the underlying of SPX/XSP from ever reaching zero? If you sold a put two days before expiration, the worst that could happen would be two 20% declines in a row (so a 36% cumulative loss)? I suppose this assumes no leverage is being used. Just wanted to see if my understanding is correct. I started dipping my toes in this strategy and trying to get a handle on what a worst case scenario could look like. Thanks!
Just to be sure: for the S&P 500 index, I'm never worried about a 100% loss over a 2-day period. Individual stocks, yes, but not the broad index.
Also: a 20% loss in the index doesn't mean that you will lose 20% in the short put. I sell my puts generously out-of-the-money. Example: In March 2020, I occasionally sold at strikes way more than 20% below the current index value. 3/16/2020: Index 2,396, put strike 1,700 = 29% below the index.
Also: depending on how much Delta you use, you might be forced to use at least a bit of leverage. Otherwise, you wouldn't generate enough income.
But back to the original question: yes, the circuit breakers will definitely offer some downside protection. Very good point!
The whole point is you will eventually lose money on selling puts, and I expect to lose around half my gains. So far I've been lucky and only lost 30% of my gains, but have mentally planned to lose the another 20-30% at any point.
A drop of 20% would be a gut punch, but SPX losing 36% in 2 days would likely be an epic problem in the real world.
Best of luck, and certainly not for faint of heart!