Selling (rather than buying) options is one of the biggest advantage options traders have. The reason is simple: Around 80% of options expire worthless, giving the seller a leg up and allowing him or her to bank profits over and over again. But even though this tends to be a short term game, there is a way to sell long term options – and win.
But before we get into the long term strategy, let’s review the basics of options.
Equity options can be bought or sold in the open market. It is a zero sum game: If someone buys put options thinking the stock is going lower, someone has to be on the other side of the trade believing the stock will go up (or not down, aka, sideways). One of these players will win, and the odds often favor the seller. The seller benefits due to market volatility, which moves stocks in both directions (up and down), and time decay, which option prices are in a constant battle against. Time decay is the reason options trading is often a short term game.
How to sell long term options
Sometimes being long options is a winning strategy. When volatility is low and not on the rise, stocks are ripe to continue rising, and options are priced more cheaply. There are various ways to sell options this environment, but my preferred method is to sell deep out of the money options (calls and/or puts), collect the premium, and then let options melt down toward zero.
The advantage of selling out of the money options is the high probability that the option finishes out of the money, given the level of market volatility relative to the current trend. If volatility is in a rising trend, you can bet those premiums will rise even if there is a great deal of distance from the price/short strike.
When trading options, it is important to manage and define risk, and we can easily do this by selling a put spread (if bullish) or a call spread (if bearish). We can combine these two and create what is known as a condor, thereby collecting premium for bullish and bearish plays simultaneously.
With any risk taking venture, there are trade-offs. Since we are playing a high probability trade, we are paid a smaller premium. However, it also means that time is on our side, and we can use as much of it until the option expires. If there is only modest market movement until the expiration, then we stand a great chance of winning when it comes time to sell long term options.
In my next article, I’ll share examples of selling premium and other ways you can gain an advantage (like during holiday periods, of which we have several coming up).
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