Option Selling

There is always debate as to exactly where option traders should sell their short strikes when option selling. The purpose of this option trading strategy is to bring in a nice healthy premium credit, and hopefully keep that credit. And the only way you are going to be able to keep that credit – at least the entire credit that is brought in at the start of the trade – is if the options that are sold expire out of the money.

So the key is to sell options that will most likely – or which have the highest probability – of expiring out of the money.

Option Selling – Standard Deviation

A great tool we can use to help us determine which options have the highest probability of expiring out of the money is the standard deviation.

This is a mathematical calculation that is based off of both price and the current volatility of the options. It calculates the probability percentages of how far the underlying ’should’ move within a given period of time.

Using standard deviation is a great method to help choose which option strike prices to sell short when option selling.

Option Selling

This option selling strategy is perhaps the most popular option and is probably the one option trading strategy that is the first introduction to many retail traders.

Option Selling – Not That Bad

Educators of more advanced option trading strategies too many times talk poorly of this options trading strategy and fault it as being too risky – or just like trading a naked put – however all option trading strategies have their good points and their bad points – and under the right circumstances the covered call strategy can be a great way to accomplish your investment goal.

Option Selling – How It Works

The covered call options trading strategy where you own shares of a stock and then you sell options – call options – against the shares that you own.

If the stock that you own ends the options expiration cycle in the money – or past the strike price where you sold the calls – the stock you own will be called away from you – meaning it will be sold – at the strike price where you sold the calls at.

This allows you to profit both from the call premium you collected when you first sold the calls – AND – you also benefit from the rise in the stock up to the strike price where you sold the calls.

The potential downside to this options selling strategy is that by selling calls you are limited or ‘capped’ in the profit potential you can get. You can only profit up to the strike price where you sold the call (unless you use rolling and other adjustment techniques we will get into in the next post).

Another downside to this options trading strategy is that there is no downside protection in place if the stock were to experience a crash.

However, many traders are already holding shares of stock without any downside protection – so by simply using this option selling strategy doesn’t INCREASE the risk – in fact if can actually decrease the risk that the un hedged stock holder is carrying by bringing in some additional cash into the account by selling the call options – to help offset the price of the stock or offset a potential drop in the stock.

There are some easy to implement hedging techniques that can be used which we will go into in the next posts – as well as take a look at what type of call options should one sell – in the money calls or out of the money calls.

To learn more about these and other types of option selling strategies like these be sure to join our free option income trading newsletter by clicking here – where you can learn more on all things about option selling

When most investors think of trading options, most likely they immediately think of buying options – either calls or puts – to try and take advantage of a move in the underlying. The other thing that most likely comes to mind, is that options are ‘risky’.

However, there is another way of trading options. A way to trade options that doesn’t involve buying calls or puts to try and take advantage of a move. And it’s also a way that I wouldn’t consider to be risky. Sure, there is risk involved – however the risk is defined, limited, and can be very low. Even better, this risk can be managed with the appropriate knowledge and specific trading methods.

This method of trading options is called ‘options selling’. It is the act of SELLING calls and puts – instead of buying them.

Usually at first this throws off traders. They will ask ‘how can you sell options without first buying them’?

All we are doing here is assuming the risk of buying them. We are simply just proving to our broker that we have the means to buy them if necessary - and then once we prove that – we sell them first – assuming the risk that we will need to buy them if need be.

But we go into the trade to begin with knowing the odds – and stacking them in our favor. Also, most of the time we will ‘hedge’ our sold position – by purchasing a call or put just beyond the option we have sold – so in a worst case scenario our losses (if they were to occur) will be capped.

By trading this way, we are able to bring premium into our account – usually a nice juicy credit – and if we have chosen which options to sell correctly – most of the time those options we have sold will wither away and decay into expiration – leaving most of the credit as our profit in the trade.

Following are some typical option selling myths…

Believing That There is An All Might Magic Type of ‘Can’t Lose’ Option Selling Position (like the Credit Spread!)

When I first learned about the credit spread strategy, the trade was positioned as a type of Mystical Trade that was nearly fool proof and almost guaranteed to always win. The reasons that were given were certainly believable. And I bought it hook, line and sinker.

Now, first things first – please understand that I do like the credit spread trade and it really can produce a great consistent return – but it’s certainly not mystical – magical. And yes, believe me – it can lose!

Just like every type of investment or strategy – unless you know what you are doing and undertand the strategy inside and out – it is possible to lose on the trade and wind up getting hurt pretty bad.

However, on the flip side – if you DO know what you are doing – and you fully understand how the strategy works and how to manage it when things start to go bad – this trade – just like all of the other option selling strategies - can be a great tool to have in your option trading ‘tool box’.

So – don’t believe all the hype you might hear about credit spreads – or any other option selling income strategy – being some sort of trading ‘holy grail’.  There is no such thing – it just doesn’t exist.

But – there certainly ARE trades – like our weekly options butterfly spread – and our iron condor – and our revolving credit spread strategy – that when combined with proper knowledge of exactly how these trades work and how to properly manage and adjust them – can come pretty darn close. Or – let’s say – just about as close as one is about to get.

There are a number of different option selling strategies which have gained popularity in the public trading circles over the last several years. These are all option strategies that the professional traders and market makers have been using for years – however – just recently they have gained more exposure to the retail crowd. Many of these strategies are also important components and pieces of other option trading strategies – which when they are combined together make up completely separate option selling strategies of their own.

One option selling strategy is the credit spread – also known as the vertical spread. This strategy entails selling a closer to the money option to bring in a premium credit – and then covereing this short position with the purchase of a different strike option further out at a lower price. The difference between these two transactions is the spread – and if the trade behaves in the way that the option seller originally thought or hoped it would – that trader can wind up with this ’spread’ difference as the final profit in their trading account.

Option Selling has become popular among the retail option trading crowd lately – due in part perhaps to cheaper commissions as well as more available option trading education.

Traders who participate in option selling are usually selling an option and receiving a premium to do so. If a trader sells an option without being covered – it is known as selling naked – which has huge risks if the underlying being traded makes a huge sudden move against the naked short position.

To reduce this risk – most option traders will sell an option but then cover it by either purchasing a corresponding option at a cheaper price – or by owning the underlying outright such as in the case of trading covered calls.