On Friday, I was sitting in my suite in Baltimore overlooking the harbor and pool.
It was almost too windy for a cigar, and certainly too cold for a robe and relaxation.
So, I stepped inside briefly inside and turned on the television. The first channel to pop on was one of the basic cable channels.
The movie was The Hunger Games.
It’s a movie about eight years old that pits teach-age kids in fights to the death for entertainment in a dystopian future. But there is a quote from that film that I remember being repeated over and over again.
Every time that one of the adults spoke to these “warriors” about to step into the arena, they would say “may the odds be ever in your favor.”
I found that quote to be fitting given my conversation with Family Portfolio readers last Wednesday.
During my Live Event, I explained that Selling Options provided a higher probability of a win than one receives Buying Options.
But what does that mean?
Remember, when you buy an option, you pay a premium for the right to own the stock at a specific strike price.
But when you sell an option, you collect the option premium from the original buyer. You want to be able to buy that contract back at a lower price or to let it expire for 100% gains.
You can also benefit if the stock falls because you can purchase a stock you want to own at a specific price.
But why is the probability higher for a win for the put seller?
There are three primary factors that impact options prices.
The time to expiration – which is represented by the date of the contract expiration. Implied volatility (or the expensiveness of the contract). And the price movement of the underlying stock relative to the strike price (the price on the contract).
With all three of these factors, each favors the put seller and limits the winning odds of the call contract buyer.
Let’s look at all three.
No. 1: Time to Expiration
Time decay is critical in options because the value of the contract is declining until it will ultimately expire. Even if the underlying stock price and volatility remain constant, the option will decline and expire worthless if it is out of the money.
Options contracts are correlated to the time to expiration because of the increased probability that it will be In the Money. In the case of selling a put option, it is tied directly to the probability that stock will fall to or below the strike price.
Let’s explain decay in a different way.
Suppose you live in Florida. You might pay for annual home insurance for $2600 a year. But for one month? You might pay $350. The reason is that the likelihood of a hurricane will happen – is more likely to happen over a longer period of time.
In this case, if you’re selling put contracts, by looking out 60 days and comparing them to 360 days, the cost of that contract will be higher. The closer that the contract moves to its expiration date, the less likely it will get to moving to the strike price, which favors the seller.
No. 2: Stock Movement Isn’t As Critical to the Options Seller
If you’re buying a call or put contract, you need the contract to be In the Money to justify its execution.
That’s not necessarily the case for a put seller. As you know, stock prices can go up, down, or sideways. You can make money in almost any of these situations as an options seller.
If you’re selling puts, as I prefer to these days, I’m always looking at technical indicators like moving averages and areas of support. Combining the premium that I’d receive with a strike price presents an opportunity for me to make money.
Take for example if you sell a $10 put contract on a stock currently trading at $11.
You receive a premium of $1.50.
This means, your breakeven price would be $8.50. So, even if the stock falls under $10 and remains between those two levels, I would make money.
I’ll take a look at support levels before I make that trade. If I see that support for say the 200-day moving average for the stock sits at $9.20, then I’ll be more confident that the stock isn’t going to break down under those levels.
The other thing that is great is that the stock could increase to $12. Because of the time and underlying stock price, that contract that I sold could decline in price. At that point, I might be able to buy it back at a large discount to what I initially sold it for.
No. 3: Volatility is Your Friend
Implied volatility (IV) is a bit challenging to understand the first time. And perhaps I should write about it tomorrow. But the easiest way to describe it is that IV measures just how expensive an option’s price is at a given moment. When IV is high, the price of the options contract is high. When the IV is low, the option price is cheap.
If you’re selling options, you want the IV to be high. That’s because implied volatility traditionally declines over time. That so-called “Reversion to the Mean” can weaken the price of the contract, and make it much more attractive to repurchase as a trader.
Options buyers want the implied volatility to be lower.
But I’m not interested in giving them a chance to see their implied volatility expand.
You want to use price direction, implied volatility, and time decay to your advantage. I typically target trades that have a 60% to 80% probability of success. But by closing the trade before expiration with an 80% to 90% gain target and limited loss target of 50%, then I’ll end up with an even higher win rate.
If you want some evidence of how my strategy works… look at my 13/13 performance in November with an average RETURN of 77%.*
Then look at my current portfolio.
Of my open 17 trades, I currently winning 13 of them.*
That’s a 76% win rate right now. And it’s very clear that my open losses are easily offset right now. I am currently just shy of $26,000 in profits right now, and I can take gains off the table any time I want.*
My portfolio continues to rally this month, and I’m just getting started in perfecting my strategy for the year ahead.
If you want to learn more about how I do it and to take your trading to the next level, you can join me for 90 days.
I’ll show you exactly how and why I make the trades I do and give you all the tools you need. I’d love to see you join today.
Enjoy your weekend,
*Results presented are not typical and may vary from person to person. Please see our full disclaimer here: https://ragingbull.com/disclaimer/