As founder of OptionSpreaders.com, I have been trading options and futures contracts for the past 40 years. If you’ve already read my story, you know it took me nearly 10 of those years to realize that selling options was, in my opinion and not without risk, the single most productive approach I’d ever found to build equity in an account. That being said, I can tell you that selling options is not for everyone.
“….selling options was, in my opinion and not without risk, the single most productive approach I’d ever found to build equity in an account.”
If you like fast action and big thrills, this is not the place for you. If you think there is such a thing as a risk free investment, this is definitely not the place for you. Leveraged Option Selling is not perfect and does have some disadvantages that you should explore when deciding if the strategy is right for you.
However, in my opinion, if you are an intelligent, rational, high net worth individual who is looking for an investment approach that targets high returns, requires a semi passive, lower stress type of management style, option selling could be right for you. To learn the complete strategy of option selling and how to use it in your portfolio – I recommend our Free Guide – The High Net Worth Investor’s Guide to Selling Leveraged Options.
While risk always plays a role in options trading, option sellers enjoy advantages not found in any other style of investing.
That being said, let first examine the disadvantages of selling leveraged options for a high-net-worth investor.
Now that you understand the potential drawbacks of selling options, lets take a look at what you can GAIN from adopting an option selling approach. Does it outweigh the drawbacks?
YOU decide.
If you would like to discover how managed portfolios with OptionSpreaders.com work, request your complimentary copy of our Private Client Group Information Pack available here now. (High Net Worth Investors Only.)
In the meantime, lets examine these advantages in a bit more detail:
When selling options with low deltas, option sellers can gain a distinct advantage over the buyers of those options. It’s pure mathematics. An option seller can sell an option with a 95% chance of it expiring worthless. The option buyer buys it on the 5% chance it doesn’t… and an even lower chance it shows a significant profit. In other words, option buyers are buying lottery tickets. Option sellers act like the lottery administrators – selling those tickets to buyers. But even if a market does start moving starkly in the buyers favor, a buyer has to hold it until the market takes it to a substantial profit level. A seller is under no such obligation.
This exemplifies the power of using applied odds over time. The strategy of selling options is, at it’s core, a strategy of using applied odds over time.
“The strategy of selling options is, at it’s core, a strategy of using applied odds over time.”
As an option seller, you gain the Confidence of knowing you can trade with the odds in your favor. The fact that most investors don’t know how to harness these odds is not your problem. Let it be theirs.
When selling (or writing) an option, time value works for you instead of against you. That means that whatever else is going on in the underlying market, you enjoy the comfort of knowing that the unwavering hands of Father Time are always working in your favor.
When you sell an option, the buyer of the option pays you a premium for that option. If you sell an out of the money option, the entire value of that option is in time value. As time passes, all other things remaining constant, the option will gradually lose its value. This is called Time Decay and it’s one of the main reasons selling options can be so effective. It is for this reason that OptionSpreaders.com pursues a strategy of selling deep out of the money options in client portfolios.
The graph above illustrates the principle of time decay and its acceleration as expiration draws near. An option is considered a “wasting asset.” Time value erodes as each day passes, accelerating as the option’s expiration nears. This is referred to as time-decay. If the underlying contract’s price does not move to the option’s strike price by expiration, the option will have no value left and expire worthless and the option seller will keep the premium. This is the concept on which our entire portfolio strategy is based. Notice that the value decays the fastest during the last 30-60 days of the option’s life.
Learn How YOU can use time value to build a custom option selling portfolio – the right way. Get your Free Copy of our training manual for high net worth investors – The High Net Worth Investor’s Guide to Selling Leveraged Options
No matter what they say, nobody knows what any market is going to do, especially on a short term basis. However, do enough homework, and it is sometimes possible to make a fairly accurate projection of where prices will not go on a longer term basis. By selling deep out of the money options, you avoid the game of trying to predict where prices will go today, tomorrow or next week. Instead you are only projecting where you think prices won’t go. For instance, if you are bullish the natural gas market, you might sell a deep out of the money put option. In this case, the market can move up, stay the same or even move down, as long as it is above your strike price upon expiration, you will still take your full profit. As an option writer it is possible that the market could move against you and force you into buying the option back at an unfavorable price. It’s important to understand the risks associated with holding, writing, and trading options before you include them in your investment portfolio.
As an Option Seller, you accept the fact that you cannot predict the future. You free yourself from the “need” for the market to move in a particular direction. You are satisfied to simply “bet” against highly unlikely events and then take a payment for your efforts – over and over again. While there is still risk in this strategy, you have the ability to profit regardless of which direction the market is moving, or even if it does not move at all.
By selling deep out of the money options, you avoid the game of trying to predict where prices will go today, tomorrow or next week.
When investing in the markets, the daily stresses of trading can wear on a person. Where to get in, where to get out, why is it moving, why is it not moving? It can lead to emotional decision making. Most of our clients tell us that selling deep out of the money options removes much of the stress and emotional decision making that is common in futures (or equities) trading.
When buying a stock or futures contract, when you enter your position is just as important as what you are buying. In selling deep out of the money options, the values typically aren’t moving as quickly. The fact that they are deep out of the money can mean that daily fluctuations in the underlying market may not have a large impact on the price of the option. Thus your timing becomes less important.
Although leveraged option trading, like any investment, carries some degree of risk, done correctly, option selling can place your position in the market far enough away that short term swings in the market may not dramatically affect your position. This not only gives you staying power but allows you to focus on longer term market fundamentals. As an options writer, you take on a higher level of risk. For example, if you write a “naked” call, you face unlimited potential loss, since there is no cap on how high a commodities price can rise. The use of fully hedged credit spreads can help mitigate the potential for unlimited potential by providing a cap on maximum losses.
But there is a side bonus to this too.
One of the hardest parts of futures or any trading is deciding when to take profits. With option selling, if the market behaves favorably towards your position, you are relieved from the responsibility of making this decision. As time value decays your option, the market will gradually take profits for you.
Upon expiration, if the option is still out of the money (has not reached your strike price), the entire premium for which you sold the option will be in your account. At this time, your position automatically closes out.
However, you reserve the right to close our your short option position prior to expiration as well. It’s a personal choice. Many of the investors we’ve worked with find that it can be easier and require less effort to simply let the market “do it for them.”
If you are purely seeking an investment with some horsepower, this could be reason #1 for you. For while option selling can be “slow and boring” for the action oriented trader, the accumulated premiums and leverage of the futures markets can make them anything but. Stock option sellers take note: This aint selling covered calls on your Microsoft. This is option selling on steroids.
If you sell a stock option and take a $200 premium, you are generally paying 10 to 20 times that amount in margin to hold that position. In commodities options, you can sell options for
Thus a margin for a $500 option premium may only require a $750 to $1,000 margin requirement from you. Option spreads can even get more favorable option margins. We’ll let you do the math.
Suffice to say, if you get satisfaction from targeting potentially high ROI on your investments and are comfortable with a certain degree of risk, leveraged (futures) option selling could be a good choice for you.
Using commodities leverage safely and to your advantage is covered in our Free Guide The High Net Worth Investor’s Guide to Selling Leveraged Options
Most forms of trading rely on taking a series of small losses and then waiting for one big gain to not only cover all of those losses and transaction fees – but also produce some kind of net profit on top. In other words, the way many traders are taught to trade is strike out over and over again in the hopes of hitting a home run every once in awhile.
“Keep losses small and let profits run” is the trading mantra of many a guru – and many a trading book. The problem is, while it sounds simple on paper, this approach runs contrary to human nature. Taking losses quick in a losing trade is psychologically difficult for many – especially those of us used to being right and winning. Taking losses is terribly difficult – especially when we’re convinced we’re right and the move against us is only slight. We’ve been taught since childhood to “stick with it, persevere, stay the course.”
But that kind of thinking can get you killed in trading. The right thing to do in life or in most any other business or profession is the exact wrong thing to do in a trading account.
“Keep losses small and let profits run” is the trading mantra of many a guru – and many a trading book. The problem is, while it sounds simple on paper, this approach runs contrary to human nature.”
And the only thing more difficult than taking a quick loss? Taking profits! Have you ever had a big winner and then had to decide where to get out? Agonizing, isn’t it? The thing runs in your favor, then comes off the highs and you think “well, that’s it, the next time it approaches that high, I’m out.” But it doesn’t quite get there again, does it? And you keep riding it down, waiting for the next “rally” to get your money. And a big profit turns into a modest one, or worse yet, another loss. The worst thing to be in trading is an optimist.
A major benefit of option selling (and one that makes if a favorite of the high net worth crowd) is that it can be effective in nearly any kind of market conditions. As covered above, this is especially true in commodities, where individual markets tend to move somewhat independently of each other.
Option Selling allows you to take the opposite approach – a more “natural” approach in line with human instinct. In option selling, you give up your chance to hit home runs in favor of hitting singles over and over again. Instead of most of your trades being losers with the hope of one big winner, you are almost statistically assured of having most of your trades come out winners. While losing trades still have to be managed, the market typically has to make a larger scale move to approach your risk parameters. In other words, it’s unlikely short term market “hiccups” will take you out of your trade.
And the best part? No more guessing where to take profits. The market does that for you automatically when the option expires.
This consistency of having a series of winning trades instead of losing trades are not only psychologically beneficial to you, the trader, but give you more focus to act when there is a risk measure to be employed or a new opportunity to capture. Option selling involves the risk of loss and is not suitable for all investors. Only risk capital should be used.
If you have a big chunk of your cash in stocks, it’s all good until you hit a market correction, a wave of volatility on some economic or geopolitical event, or an outright bear market.
As an option seller, especially a (leveraged) commodities option seller, you have the ability to be successful in these kinds of markets. While your golf buddies are complaining about the “rough waters” the market is in, you can (potentially) be sailing in a cool breeze. Remember, you’re deep out of the money – way over or way under the market. While this doesn’t make you bulletproof to all market events, it does give you a great deal of flexibility and diversity to deal with what may come along. The end result for you is the peace of mind of knowing your portfolio has the potential to produce no matter what is happening in the financial markets.*
*All OptionSpreaders.com material is provided for educational purposes only. Completing or viewing any OptionSpreaders.com content does not guarantee that an individual has obtained a minimum level of knowledge or skill, is not an indication of investor suitability to trade options, and should not be used to determine an individual’s trading or investing competency or sophistication. Any strategies discusses, including examples using actual securities and price data, are strictly for illustrative and educational purposes. Past performance is not a guarantee of future results.
Why Credit Spreads?
