Option trading all comes down to probability of profit. Statistically, option sellers always have a better chance of profiting. It's true that when you sell options your profit is limited, but your chances of walking away with that profit are high. The reverse is true for option buyers. Their potential profit is limitless, but the odds of achieving that profit are very small, especially with out-of-the-money options.
Why not put the odds of success on your side and learn how to become a smart option seller? Naked (uncovered) option selling entails unlimited risk and limited profit, but there is a strategy of option selling that has limited risk as well as limited profit. It's called a credit spread. In a credit spread, you sell an option and buy a cheaper option at the same time to limit your risk. Since you are selling a more expensive option than you are buying, you get to take an initial credit into your account. As long as you implement the trade as a spread, you will never be exposed to unlimited loss, as is the case with naked option selling.
Credit spreads come in two types -- the bear call spread and the bull put spread. A credit spread is always used with either all calls or all puts and within the same expiration month. A call credit spread consists of selling a more-expensive, lower-strike call, and buying a less-expensive, higher-strike call. A bull put spread consists of selling a more-expensive, higher-strike put and buying a less-expensive, lower-strike put. The best outcome of a credit spread is to have all the strikes expire worthless so you can keep the entire premium you collected at the beginning. Credit spreads should be initiated using the two closest months to expiration. This is when time decay starts to accelerate, and it gives the underlying security less chance to make a move against the position.
Credit spreads can be used with individual stocks, futures options, or indices such as the NDX, RUT, SPX Standard & Poor's 500, and so on. If you are playing the stock market, credit spreads are preferable with an index such as the SPX, NDX or RUT options because there's less chance of a gap move than there is with many individual stocks.
Credit spread trading is a simple, safe, and stress-free type of trade that does not require a great deal of monitoring. You just place the trade, collect the credit, and wait for the options premiums to decrease or expire worthless. And if the underlying security starts to move against your position, there's no need to worry; your loss is limited, no matter how far the security might move. Plus, you can always unwind the spread at a small loss before expiration occurs.
Options lose all of their time premium by expiration, which is referred to as time decay. Because they have no intrinsic value, out-of-the-money options expire worthless.
I started trading options in the late 90's. After selling my first option and collecting an immediate credit I and became an option seller for life. I became a student of option selling strategies and started selling covered calls on stocks I brought and owned. I was doing OK collecting premiums month after month until a few of my stocks tanked and my losses over a 2 month period wiped out 6 months of profits. My mistake was picking not so good stocks for this covered call option selling strategy. So I became a student again and discovered an option trading strategy that is truly amazing.
Selling Option Credit Spreads on the broad based stock indexes was my new strategy. My goal was to collect premiums each month using OTM (Out of The Money) options spreads, specifically Bull Put Spread and Bear Call Spreads on the SPX index. I was choosing spreads that were very far OTM so that I had a greater cushion which reduced my risk.
Selling spreads is more akin to waiting for the big move to occur and it rarely does. Time decay is very relevant because despite being a spread, the spread does have a significant rate of decay in the last week or two. The beauty of this strategy is that you do not necessarily need to sit on top of it all the time. If your strikes are 40-60 points OTM and the SPX is up 1.20 today, you gain nothing by checking the quotes every minute. You can just check in the morning and at the close at your leisure as long as you are sufficiently OTM. When the market starts moving closer to your short strike, some due diligence is required. With credit spreads you want the position to expire worthless or buy back for way less that you sold it for.
The goal is to collect premium month to month. Using OTM spreads is a way to do this without predicting the market for the month. In any given month, the market can still move sideways, lower or higher and your positions will still be profitable. You are trading without concern over market direction for a major crash lower.
Today I employ a very safe and conservative Iron Condor credit spread trading strategy. My strategy with iron condor trading is to leg into the trade by selling the Bull Put Spread first for .20 - .25 cents. This is only a 2% - 2.5% return but the trade is very safe and the short strike is usually 60 points or more away from the current index price. I will then complete the condor by selling the Bull Call Spread later on for another .20-.25 cents, but only if the trade is safe. Safety is the key to my strategy with a goal of earning on average a 3% return each month.
Both Fitforlife & Brad Griffin are contributors for EditorialToday. The above articles have been edited for relevancy and timeliness. All write-ups, reviews, tips and guides published by EditorialToday.com and its partners or affiliates are for informational purposes only. They should not be used for any legal or any other type of advice. We do not endorse any author, contributor, writer or article posted by our team.
Fitforlife has sinced written about articles on various topics from Personal Finance. Brad Griffinhttp://www.indexspreadoptionstrading.com. Fitforlife's top article generates over 2400 views. to your Favourites.
Brad Griffin has sinced written about articles on various topics from Cleaning Business, Personal Finance and Investments. Brad Griffin is an Accountant and CPA and has been Investing in the U.S Stock Market for 10 years and the options market for the past 5 years. I am now sharing my knowledge and success trading options at my website. Brad Griffin's top article generates over 2400 views. to your Favourites.