A Note for the Serious Investor:
The material that follows is written for high-net-worth and accredited investors who are serious about understanding the use of commodity options in a professionally managed portfolio. Futures and options involve substantial risk of loss, are not suitable for all investors, and only risk capital should be used. This article is for educational purposes only and is not a recommendation to buy, sell, or hold any specific futures contract, option, spread, or commodity position.
Deep out of the money options tend to stay out of the money, if not deep out of the money.
Investorglossary.com
Picture yourself driving a car.
If you drive down the highway at 95 miles an hour, you are going to get to your destination in a hurry. However, there are two major drawbacks: 1. There is a higher chance that you will be in an accident and 2. If you do have an accident, there is a higher chance you will get hurt.
The same holds true for selling options.
It is a common fallacy among option traders that in selling options, one must concentrate on options with 30 days or less remaining until expiration. The logic goes that as this is when options experience the fastest rate of time decay, why not only sell “short time” options and get the fastest time decay possible?
Options are known as “wasting assets” and their value gradually decays as they approach expiration. If they expire out of the money, the option goes off the board worthless, meaning the seller keeps any premium he collected. The chart above shows the rate of time decay of an option as it nears expiration. Note that the rate of decay accelerates as the option approaches expiration.
I know of some traders that do utilize this strategy and hats off to them. However, I would consider this a very aggressive, almost day trading approach to option selling. The investors I work with tend to be looking for a more measured, research-based approach, not high-speed thrills. If you fall into the latter category, you may want to consider why some option sellers prefer options with more time left on them in order to get more distant strikes. Here is why.
The value of an option is made up of three main components:
- Volatility
- Time remaining until expiration
- How close the strike is to the price of the underlying market
You can sell a credit spread with 3 to 5 months left until expiration that is deep, deep out of the money, and collect a meaningful premium in many of the most actively traded contracts. Now you can get that same premium for a 30-day credit spread in that same market. The upside is that you only must wait 30 days to expiry and, if the market behaves favorably, you will get very rapid time decay.
The tradeoff is; to get this premium, you will generally have to sell much closer to the money. This means that even a small “hiccup” in the underlying market and your short option could be in the money. This could happen rapidly and you could lose funds in a hurry, one reason, incidentally, that option selling gets a bad rap in some “less enlightened” circles.
For instance, in the example below, trader John is neutral to bearish coffee. In October 2025, with coffee trading near $3.80 per pound, he could sell a December Coffee $4.50/$5.50 call spread, or he could sell a May Coffee $7.00/$8.00 call spread. Which one looks more comfortable to you? Suppose trader John is wrong and coffee goes to $4.25? How about $5.00? If it did, which option do you think John would rather be holding, one that is in the money, or one that is still $2.00 out of the money?
Sure, during typical market environments you can buy out of either one any time you want. But would you rather buy back an out of the money call than an in the money call?
Now, I am not proposing that you cannot lose money by selling deep out of the money credit spreads. You absolutely can. What I am saying is that the market generally has to move further to put your option in the money. Remember that as an option seller, you want your short option to expire out of the money. It doesn’t matter where, as long as it is out of the money. By selling with more time, you may be able to sell further out of the money. In my experience, this can be an advantage, especially if you are familiar with the fundamental factors driving the underlying contract price.
Long term, sustained moves tend to require some kind of fundamental rationale. One potential advantage to selling deep out of the money options is that it may place your position high above or far below the market in an attempt to ride out short term swings in the underlying caused by rumors, sensational news events or short-term technical breakouts. Close to the money options are more vulnerable to these types of events. Deep out of the money options may provide more room, although they still involve substantial risk and can lose money quickly if the market moves sharply against the position.
True, there will be some speed demons out there that will argue that shorter is still better, that long term options “give the market too much time” to move against you. In selling options on fundamentally based commodities markets, that argument seems nonsensical to me. However, to each his own.
I’ll take the slow road, even if it means waiting longer to reach my destination. I’d rather give myself more room on the road than end up in a ditch trying to get there quickly. If you are the type of qualified investor that prefers a more patient, research-based approach over adrenaline, going deep may be a strategy worth understanding.
If you are an accredited or high-net-worth investor who would like to learn how you can start incorporating seasonals and fundamentals into an option-selling portfolio with OptionSpreaders.com, be sure to request your complimentary Info Pack and The Option Selling Solution at OptionSpreaders.com.
Justin Cardwell
Director of Research at OptionSpreaders.com
For more information on managed leveraged option selling accounts with OptionSpreaders.com, request a complimentary Investor Information Discovery Pack here or call 888-383-2779 to schedule a free consultation*. (*Qualified investors only. From outside the US call +1 813-999-0026.)
