Selling Options
Selling Options for income is one of those homilies widely embraced by retail brokerages as a safe, conservative strategy recommended to their customers when, in fact, successfully selling Options consistently is a highly complex trading strategy. There was a time, in a bygone era, when Option Income Funds were all the rage. Where are they now? Some 'studies' have concluded that as much as 80% of all Options expire worthless or, at least, were not profitable for the buyers. Really? The premiums paid must have been really huge! If this were true, how come the Option income funds were blown away? To start with, understand one thing: Selling Options is a game where you win small and lose big. One bad loss can wipe out a lifetime of profits. That's not an exaggeration. It has happened. On more than one occasion. Successful Options traders are among the shrewdest, most sophisticated financial professionals in the business. It would be wonderful if all that needed to be done when selling Options was to write an Option, wait for it to expire worthless, and write another Option. You could even quit your day job. In your dreams! Consider that every new Option series starts out with one Call and one Put at-the-money plus, at least, one pair each out-of-the money and in-the-money. That comes to a minimum of six new Options available, two of which (33%) are starting out in-the-money. No matter what the market does (up, down, or sideways), at least two are guaranteed to finish in the money. If the market climbs like a home-sick angel, all the Calls (three of the six) will be winners. If the market crashes, all the Puts (again, three of the six) will be profitable. Each strike price starts out with four expiration dates available and new strikes are added as the market passes through predetermined levels. All told, that's a lot on anyones' plate to keep track of. And that's just for one stock. How many constantly changing stocks and their related Options do you want to monitor? The possible strategies employed are, virtually, unlimited. Without a computer, good luck with that. Professional Options traders are very much into math. Whether buying, selling, or both (known as 'spreading') they are constantly aware of the 'greeks' (the theoretical mathematical components comprising Option pricing theory - see Black-Scholes Model, for instance. Try not to get a headache reading it). Option sellers (writers) make their money by selling the 'time value' of an Option; the out-of-the-money portion of an Options' price (aka 'air' or 'puff'). If the Option is out-of-the-money to begin with, the entire price is made up of 'air' or 'puff' (some might call it 'hope'). The more 'hot air' (volatility), the better for the seller who, quite naturally enough, wants to see the entire Option expire worthless. Zero. Zip. Nahda. Only if the Option actually goes into-the-money (that is, having 'intrinsic' value) will the seller (writer) have to come up with the stock in order to make 'delivery', if 'called' ('assigned' or 'exercised') in the case of a Call, or, in the case of a Put, have to come up with the cash to actually buy the stock. Usually, sellers (writers) don't let it go that far, if they can help it. They, typically, 'cover' their 'shorts' by buying back the Options to 'close' out their positions. They might even sell (write) another Option (called 'rolling' the position) thus continuing their selling Options campaign. Selling 'time value' and buying 'intrinsic value' is the name of their game. Only a fool would sell (write) uncovered ('naked') Options. Why risk unlimited loss for a small credit as your only profit? For this reason, professional traders prefer to sell (write) 'spreads'. 'Spreading' means buying one Option while simultaneously selling another. If the Option sold (written) is higher in price than the Option bought, the position results in a net credit taken in with a known limited risk (distance between strikes less credit received). Although the position has less potential profit due to the smaller credit, the trader can make the same dollar profit by increasing the number of spreads. For example, if a 'naked' Option takes in 5 points with unlimited risk and a 'spread' takes in 2 1/2 points with limited risk, selling (writing) 2 spreads takes in the same money and you sleep better. Professional traders always 'hedge' their positions. No matter what happens today, they must always be able to come back tomorrow. Profits take care of themselves. Losses never do. The business of consistently selling Options successfully is a valuable skill that is acquired only after much diligent study and hard work.
Back to Options Strategies What Are Your Thoughts On This Topic?What are your thoughts on this subject? Share them!
|
