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Have you ever heard it said that most futures options expire worthless? The Chicago Merchantile Exchange estimates over 80% of all options sold expire worthless. So why aren't you selling them instead of buying them?
BENEFITS OF OPTION SELLING
Time Value Decay
When selling (or writing) an option, time value works for you instead of against you. 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. It is for this reason that Liberty Trading pursues a strategy of selling out of the money options.
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 does not move far enough by expiration, the option will have no value left and expire worthless and the option seller will keep the premium. Notice that the value decays the fastest during the last 30-60 days of the option's life.
Taking Profits
One of the hardest parts of futures trading is deciding when to take profits. With option selling, if the market behaves favorably towards your position, you won't need to make 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.
Lower Stress
Most of our clients tell us that selling out of the money options removes much of the stress and emotional decision making that is common in futures trading. Although all futures trading 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 effect your position. This not only gives you staying power but allows you to focus on longer term market fundamentals.
Being Close Is Good Enough
By selling options, you avoid the game of trying to predict where prices will go. Instead you are projecting where you think prices won't go. For instance, if you are bullish a market, you would sell an 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.
What about the risk?
A short option carries the same risks as a futures contract with one major exception: It will generally move slower than a futures position. This gives a trader more time and latitude to exit should the market move against his option. Nonetheless, many investors are more comfortable with a limited risk aspect to their trades. It is for this reason that we recommend covered spreads to more conservative portfolios. Your Liberty Trading Broker will work with you in determining the risk parameters of each trade and which positions may be right for you.
Even though we believe selling options can potentially put the odds of success in your favor, it still requires good, solid market analysis. The difference is, selling options gives you a larger margin for error. You don't have to be as exact as in the futures market, only close.
If this sounds interesting and you'd like to learn more about selling options in your portfolio, feel free to contact us or request your free option sellers information pack on this website.
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