Many market participants say trading options is complex, hard to learn, and most people who try will struggle or either fail. That’s probably because they don’t know which options strategies to use, and what environment to use them in.
Heck, I struggled with trading options at one point, and of course, it was frustrating. But I realized options weren’t the enemy — I just didn’t know how to trade them properly because I was mainly focused on buying options.
You see, the “simplest” options strategy is buying calls or puts… and that’s where most beginners start. The thing is, by doing that, the odds are actually stacked against you.
What do I mean by that?
When you buy options, not only do you need to pick the right direction, you also need to get the timing and volatility right.
However, that all changed when I implemented spread trades. My strategy allows me to profit from all the factors that crushed me as the buyer of an option. Right now, I believe it’s the best time to use this strategy, and it’s an edge I have over options buyers.
Now, selling options premium can be lucrative, especially in this market environment.
However, there is a give and take with all good strategies. When you sell options premium, there are a lot of pros and just one weakness that I see (I’ve actually figured out a way to get rid of the cons with Weekly Windfalls).
For example, if you don’t already know, many of the options listed on exchanges expire worthlessly. Heck, there are some statistics that show more than 70% of options expire worthlessly.
If you’re a buyer of options and have been losing money… that might be the reason why. You see if 70% of options expire worthlessly, and you’re long… the odds are stacked against you.
Not only that but with all this volatility, the options premiums are so high — and you would need massive moves just to break even.
On the other hand, if you’re a seller of options… the odds could actually be stacked in your favor.
Well, if you know how to sell options premium… you could be in a position to generate double-digit percentage returns.
Time Is On Your Side As An Options Seller
If you don’t know already, options have expiration dates. What that means is when you buy an options contract, there is a useful life… and over time, the options lose value due to time decay.
Those who buy options are at the mercy of time.
You see, if the option is out of the money, as each day passes… the options lose more and more value.
On your trading platform, you should be able to find the “Greeks” and what you want to be on the lookout for is “theta”. This is how sensitive an option’s price is to time.
For example, if the theta is -0.15 for a specific options contract, that means if you’re long 1 contract, those options would lose $15 in time premium (options have a multiplier of 100).
You may think that’s not a whole lot… but it adds up. You see, as the options get closer and closer to the expiration date, the time decay actually accelerates.
Think if you’re a seller of options. You wouldn’t be at the mercy of time decay… and another person’s loss is your gain.
That means if you sell options with a short time to expiration… that time decay will accelerate as each day passes, and you can achieve big gains fast.
That said, time decay works in favor of options sellers… and works against option buyers.
Another pro of selling options is that you don’t have to be right on the stock direction.
Direction Doesn’t Necessarily Affect Options Sellers
Now, stocks either go up, down or trade sideways.
When you buy options (like buying a call or a put), you need the stock to move in your direction. Not only that, but you also need the volatility to go up too.
That said, you’ve only got a 50/50 chance here. Either the stock moves to your favor or it doesn’t.
But what about option sellers?
Well, let’s use an example. Let’s say you sell call options. As long as the stock does not go above the strike price plus the premium collected by the time the option expires… you’ll be profitable.
That means if the stock goes down… you make money… if the stock is choppy and just trades in a tight range … you make money… if it moves up a little (but not above the strike price)… you make money.
Conversely, the trader you sold those options (they’re long options) needs the stock to break above the strike price for them to be profitable.
Think about it like this… would you want to limit yourself and be right on the direction… or would you want to make money and not really care if you’re right on the direction?
I’ll take the latter any day.
Now, there is one con of selling options.
Limiting Your Risk When You Sell Options
When you sell a call option… Your risk is theoretically unlimited. A lot of people are actually against selling options because a number of things can go wrong.
For example, the stock could announce positive news, and those options can get in the money… then you would be on the hook for delivering those shares.
Similarly, when you sell put options, the risk you take can be big. Although it’s not unlimited like calls if the stock drops significantly and gets below the strike price of the puts you sold… well, it could get dangerous.
Of course, these are all valid concerns.
To be honest, naked selling options is something I’m not comfortable doing.
However, the beauty of options is the fact that they allow me to be creative. That means if I want to sell premium, I can actually “buy an insurance policy” (also known as hedging my position) so that my risk is defined.
In other words, I can go to bed without having to worry whether my short premium position will be affected by a massive gap up or down.
As you can see, there are many pros to selling options premiums… and if you know how to sell options premium the right way, you define your risk.
By purchasing “insurance” when I sell options premium, I actually reduce my risk and still have an edge in the market. In this environment, I believe this strategy could be beneficial because credit spread traders would be selling when implied volatility is extremely high and premiums are juiced.