Ask a Broker
April 2007
This month, Lind Plus Senior Market Strategist Carol Hurley discusses selling option premium and other options strategies, and the risks involved.
Q: I am interested in selling option premium, but I do not want to be exposed to unlimited risk. Can you tell me what is involved and give me an options strategy where my risk parameters are defined and explain any timing factors?
A: There are several option strategies available to take advantage of various situations in the marketplace. Selling option premium (or writing options) is simply selling puts or calls on a particular market and collecting the amount of cash that particular option is worth at the time of the sale. While you do collect premium as an option seller, this strategy is not for everyone, as you can also face unlimited risk. If you are strictly selling premium, your intent would be to let the option price deteriorate so you could purchase it back at a lower price for a profit or, let it expire worthless to keep the full amount of premium that you sold it for. Premium sellers typically look for options which are expiring in a short period of time so that time decay is working on their side. Other considerations include volatility, market direction, strike price and your risk tolerance.
A volatile market will have "volatility premium" built into the price of an option. This means that sellers of these options are demanding higher prices for those options to take on the additional risk associated with that particular market. The RBOB options are a good example. Based on the closing price at the time of this writing, the June 2007 RBOB 196 puts settled at 200. That means that the market will pay you $840 to sell that put, which expires in 33 days and, is 26 full points out of the money. In general, you collect more on a volatile market, compared with a quiet or stable market.
As for risk management, most options on contracts at the CME and CBOT will take stop orders. However, several options do not trade in the overnight market. A stop order becomes a market order, so the risk would be if a large move happened overnight against your favor, and your fill price may be worse than your stop price.
As for strategy, let's say you've been watching the euro, which has been in a strong upward trend and has just reached a new historical high. The June euro options have an expiration date of June 8. If you are bearish and think the market is due for a correction, say for example, you decide to sell the June 2007 $1.3850 call for 45 points and collect $562.50. June futures are trading about 180 points away, at $1.3670. Let's say you want to risk approximately $500. You could place a stop 40 points above your sale price; that is, buy one June 2007 $1.3850 call at 85 stop. Let's say the market goes your way immediately and the $1.3850 call is trading at 15. You can either lower your stop, or take your profit of 25 points. You do not have to wait until expiration to exit your position.
An alternative would be to do a credit spread. Under the same circumstances mentioned above, say you decide to sell the June 2007 $1.3700 call for 93 points and buy the June 2007 $1.3800 call for 57 points. You collect $450 (93 points – 57 points = 36 points x $12.50 = $450. The $1.3800 call would be your protection, and your worst-case scenario has been defined. Any move above $1.3800 will be covered by your $1.3800 call.
If the market settled at or above $1.3800, your maximum loss would be the 100-point difference between the $1.3700 and $1.3800 call, which at $12.50 per point, equals $1,250. Subtracting out the $450 premium you collected, your loss is defined to $800.
There are ways to hedge your futures positions with options as well.
For more specific trading strategies to suit your particular situation in this or other markets, please feel free to contact me.
Carol Hurley is a Senior Market Strategist with Lind Plus. She can be reached at 866-790-4371 or via email at churley@lind-waldock.com.
Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.
Futures trading involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
© 2007 Lind-Waldock, a division of Man Financial Inc. All Rights Reserved.
