selling options

Quoting narafa

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Ok, here are my 2 cents....

First of all I assume that you are talking about stock options...

Major tips for selling (Writing Options):

1- Pick a stock which has experienced increased volatility lately..Don't sell options on a low volatility stock, why?? Because if the stock is non-volatile, the options pricing on the market will factor this in, and thus premiums are low by nature...If you write an option in such a situation (Either a call or a put), you will receive a low premium for your sold options, and the risk that the stock becomes volatile for any reason will affect the options pricing against you...It doesn't really matter if the stock goes up or down quickly, it's a matter that it moved fast and volatility is increasing, so the premium you received was low and the option you sold is worth more now because of the volatility factor..

In the case you sell options for a volatile stock already, you will find that options are priced high enough to amount for that volatility, so you will receive a higher premium for every contract...The worst case scenario is to see the volatility of the stock increasing, which is not likely to happen in 95% of the cases for already volatile stocks...On the other hand, it is likely to see volatility decreasing or cooling down, so options prices adjust and you gain from that just because volatility decreased, even if the stock price went against your position slowly...


2- Watch out the liquidity of the options...If you sell 50 put contracts for stock ABC, and after 10 days, the stock moved down sharply threatening your position, you might want to consider covering your position and taking a small loss....If the options for that stock (ABC) are not liquid enough, your 50 contracts might be a problem, you might be forced to buy at different prices and find yourself bidding up the option price, so beware...If the liquidity of the options is not great, don't sell large amounts of contracts, or in other words, thing of your exit in the worst case scenario, because the potential loss is huge


3- Watch the margin requirements with great care...Some brokers have different margin requirements other than the default for certain stocks and they change it frequently..Ameritrade is an example for such a broker...You will have to check their list to see if the stock you want to play with is on the list or not...

Even with the normal case, watch your margin carefully...Maint. Margin is a variable because it depends upon the stock price and the out of the money amount and these 2 variables change everyday...You don't want to get a margin call and be forced to close your position earlier than you should...


4- Watch for the week before expiration and play it safe...If you sold 20 $50 March puts out of the money contracts for ABC for $250 per contract for example...On the week before the expiration, the stock is trading at $57, and you see that there are no bidders for the option available, and the sellers are offering to sell at $5 per contract, don't be greedy for nothing, close your position, shit happens, and the stock can really move $10 in less than 5 days...(Check Google last Friday)...


5- Watch out for earnings release dates before you even open your position


6- Be very cautious when you establish a short put position...Stocks fall faster than they go up, maybe because of gravity, I don't know, but it's proven historically that they do


7- Naked calls have unlimited loss potential, while naked puts have limited loss potential, although they are both treated the same and many websites will tell you that both have unlimited loss potential


8- Consider hedging your positions when you are in doubt...Naked calls or puts limit your profit to the premium you will get, so it won't be a problem to hedge your position, it will just reduce your profits a little bit, but will make your probability higher...Hedging is a pain in the ass when you are holding something of unlimited profit because it limits the profit, but in the case of selling options, the profit is already limited from the very beginning, so you won't lose a big advantage if you cut down some of those profits for increased probability...

For example, if you are short some puts for March, you might want to consider buying some puts for February at the same strike price, the shorted puts will give you higher premium than what you will pay for the February ones, but you will be secured for a month, and naked for the rest of the next month...This can be done when you are not sure if the stock will move fast against you or not, just a clue, or to neutralize the effect of the earnings release coming out in February for example...

Another solution is to sell puts for March at $50 strike and buy puts for March at $45 strike for example...You are virtually secured for the whole period...Both puts should be out of the money...The only case you will lose is the stock getting stuck between $45 and $50 before expiration, in which your sold puts are in the money, and your long puts are worthless...By that time, the puts would have decayed in value greatly to allow you to get out almost at breakeven from your positions or with a small loss...Plus, the probability that the stock gets stuck between $45 and $50 just before expiration are very very slim...Yes the premium or the profit from such a strategy is small, but how many times will it miss?? 1 out of 10?? That's good ratio...


9- If you are covering your short position and find no bidders and the sellers are not offering the lowest price for the contract which is $5, be the bidder...Enter a limit order to buy closing your short position at $0.05 or $5 per contract...As soon as you refresh the page, you will find that your order has been executed....Market makers and floor traders will immeditely take the other side of the trade and execute your order....


Last thing, I think this should go in the stocks forum, so I am moving it there


Thanks,

Nader

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Quoting mmills4x

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I suggest you consider buying/selling options on the Q's (QQQQ). They
are very liquid, and have small increments between strike prices. You
can also buy longer term options on the Q's, called LEAPS and sell shorter
term options against them to generate monthly income. There
is a probability calculator in the options section of Yahoo finance that
provides the probability of profit for the symbol you input and the strategy
you are using (long/short/straddle, etc.) Don't trade options (or anything)
until you educate yourself. One of the best options books I have read is
called Options Made Easy by Guy Cohen.

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Quoting johns

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I had a friend the other day tell me that I SHOULD NEVER BUY an option but sell the option as in "write the option".

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Quoting merlin

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your friend is very smart. writing is the way to go. but you need to be hedged in some way because disaster can come at any time. look no further than the goog puts i sold last month (see goog thread in stock forum). i would have been margin called if i had not gotten lucky. that was not a large position in relation to my entire portfolio and thats why i was playing so risky, btw.

one of the best ways i know to trade hedged options is a form of dispersion trading. it goes like this...

you BUY a straddle (puts and calls at same strike) on a stock with a low IV (in relation to its history). to cover the -$theta on the position, you SELL a similar straddle on the index that the stock is in. this way, if the whole market crashes or explodes, you lose money on your short index straddle and make an offsetting amount on your long stock straddle. this makes sense because if the whole market crashes, its not like your stock is going to stay the same. HOWEVER, your stock can crash or explode WITHOUT the index, so there is a possibility that you make a lot of money on the long straddle and lose very little on the index straddle.

a simple way to phrase this strategy is "finance your long stock straddles with short index straddles".

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Quoting merlin

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your friend is very smart. writing is the way to go. but you need to be hedged in some way because disaster can come at any time. look no further than the goog puts i sold last month (see goog thread in stock forum). i would have been margin called if i had not gotten lucky. that was not a large position in relation to my entire portfolio and thats why i was playing so risky, btw.

one of the best ways i know to trade hedged options is a form of dispersion trading. it goes like this...

you BUY a straddle (puts and calls at same strike) on a stock with a low IV (in relation to its history). to cover the -$theta on the position, you SELL a similar straddle on the index that the stock is in. this way, if the whole market crashes or explodes, you lose money on your short index straddle and make an offsetting amount on your long stock straddle. this makes sense because if the whole market crashes, its not like your stock is going to stay the same. HOWEVER, your stock can crash or explode WITHOUT the index, so there is a possibility that you make a lot of money on the long straddle and lose very little on the index straddle.

a simple way to phrase this strategy is "finance your long stock straddles with short index straddles".

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Quoting johns

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I don't want to buy any straddles. I want nothing to do with buying. What's the best way to hedge when your selling options outside of the money? Do you even need to hedge when you are really far outside of the money? I'm assuming not, I will just liquidate my position if something crazy happens. I'm assuming I won't be affected that much even if something drastic happens.

Right now I want to get my feet wet so I plan on writing options outside of the money. How much risk is there writing call/put options outside of the money. I realize there's a good amount of risk writing options within the money, but how screwed can you get if your outside of the money. I plan on liquidating my positions once the option price doubles. I'm only planning on writing options in the $250 value for maybe ten different markets. I don't want to put all of my eggs in one basket. It all comes down to probability. What are the odds that you sell (10) $250 call options in ten different overbought markets, how many will go against you? Maybe one at the most two. So I will lose at most $500 while gaining $2000.

My total profit per month should be$2500 if all the options expire worthless, which is a very good chance they will. I'm also planning on going into markets that are extremely overbought or undersold.

What do you think? It's just to get my feet wet and get some money coming in.

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Quoting johns

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Do you even need to hedge when you are really far outside of the money? I'm assuming not, I will just liquidate my position if something crazy happens. I'm assuming I won't be affected that much even if something drastic happens.

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Quoting merlin

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wha???? john, you are talking crazy man. do you know what delta is? selling far OTM options puts you in a position where deltas can pile up VERY FAST. you can, and will, get fucked, even if something less than "crazy" happens.

do you have a software that will allow you to plot your option P/L graph? if not, you should get one before you sell even a single option. you dont sound like your respecting the risk associated with option writting, you may need to see it in graphical format to see just how dangerous it can be.

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Quoting johns

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I'm going to sell a March 1360 call for $275 which expires on March 16. I have a month and a half until expiration. Even if the S&P 500 reaches 1360 at expiration the option will still be close to worthless it may be worth a little bit but not much. What are the odds of the S&P rallying that much?

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Quoting merlin

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i use TradeStation, but there are many others out there. you should be able to draw the expiration graph by hand, but the realtime graph is much more tricky to do by hand, you need some software. i highly suggest you have a picture of your realtime P/L graph before writing an option because otherwise you wont understand your risk. its one thing to understand your P/L at expiration, but in reality there are margin requirements that are based on your realtime P/L that will exit you out of positions when they start moving against you. the further OTM the options are, the quicker that margin call will sneak up on you, because your deltas will accumulate mega fast.

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Quoting johns

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Thanks I'll check them out. Do you have any suggestions as to how to hedge when you write an option outside of the money?

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Quoting johns

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Hey Merlin,

I was wondering if you knew of any inexpensive software just for drawing the expiration graph. Tradestation looks good but I only will need software for writing options

Thanks,

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Quoting johns

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No I don't. Where can I get some software to do it?

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