Low Risk Options Trading Strategy - Option Spreads
- Thread starter AW10
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Hi
Today I will post here different ways to sell premium. I am clear, that some of the ways are more risky than other ones. I am also clear,that some brokers in the world do not allow some of the ways, which are explained here. Even then : As option traders it is good to know different ways to collect premium.
VERY IMPORTANT : Do read the final word at the end of the post !
--- 7 Ways to Collect Higher Option Premiums ---
- 1. Sell Naked: ( Not for beginners )
Spreading has it's merits. But for pure premium collection, there is no way to get bigger premiums and realize them faster than selling naked. While the word conjures up images of being "exposed" and thus discourages many investors from exploring it, naked option selling can be done responsibly and effectively. While risk must sometimes be managed a bit more closely than "covered" risk, you are doing yourself and your portfolio a disservice if you do not consider selling naked in at least some situations. It's the power play, the strong side sweep, the right hook in an option seller's arsenal.
- 2. Sell Strangles: ( For beginners and pros / Can do in India )
Selling strangles is for many a favorite option selling strategy. While not ideal for hard trending markets or breakout moves, selling strangles (selling a put and a call in the same market) can be an amazingly versatile strategy. It can be deployed in a wide variety of market conditions and has a magical effect on boosting your premium: Doubling your premium collected while reducing your margin requirement (as a percentage of premium).
For instance, selling the put may bring in $500 premium and carry a $1,000 margin requirement. Selling the call may do the same. But selling them at the same time brings in the same premium but lowers the margin requirement. Thus, selling the put and call together brings a greater return on invested capital. As a bonus, selling a strangle also comes with some built in risk temperance. A move against your call is at least partially offset by gains in your put (and vice versa). Thus a strangle can be a flexible way to build account premium quickly.
- 3. Sell Closer to the Money: ( Not for beginners )
Collecting higher premium, selling closer to the money will increase the premiums you collect. For the risk adverse, it may not be your first choice either. The closer you sell to the money, the better chance for your options to go in the money - a place no option seller wants to be. At the same time, moving a strike or two closer can sometimes make a big difference in the premium you bring in. Especially in markets where deep out of the money strikes are available and fundamentals support your position. For instance, if Coffee is at 1.50 per pound, it probably isn't going to make a big difference from a risk standpoint if you sell a 2.90, 2.80 or 2.70 call. But it could make a noticeable difference in the premium you collect. In this type of situation (all strikes are deep out of the money,) selling the closer strike can make sense.
- 4. Sell more time: ( For beginners and for pros )
In my opinion, this is a more conservative method of collecting higher premiums than #3. It's a fact that the more time left on your option, the higher premium you can collect. The tradeoff is that you have to wait longer for the option to expire. Many traders do not have the patience for this. Others feel that selling more time allows a greater window for something to "happen" in the markets. If you want to reduce the chances of something "happening" to your position, know your fundamentals. Sharp moves can happen in any market. However, they are less likely to happen in markets where fundamentals do not support them. Selling more time can be a slow path to higher returns.
- 5. Sell Volatility - Fade the News: ( Not for beginners )
Its not secret to most any option seller that higher volatility means higher premiums. Volatile markets bring in more speculators who not only drive prices in the underlying, they buy options. This means demand and thus premium for the options goes up. Typically, as an option seller, this will mean opportunities for you. This is not to suggest you should sell in front of runaway, breakout moves. However, a spike in volatility often makes the "ridiculous" strike prices. People (investors are people), tend to get carried away or lose their heads in the excitement of fast moving markets.
As an option seller, you can use these situations to your great advantage. After a spike in volatility can often be a great time to sell options. A good example is after a surprise report. An unexpected number comes out and prices of the commodity in question must adjust to reflect the new numbers. This is often (though not always) done quickly - over a period of 1 to 3 trading sessions. After that, the market has priced the new number and trading resumes as normal.
It is even common for the options to "price in" the most extreme possibility in the first day and then adjust its value lower - even as the price of the underlying continues to move towards it. These can be ideal conditions for collected fat premiums - again, however, only if you know the fundamentals. Other types of volatility surges, such as weather events are more fluid and require more caution. Reports are solid and the market can adjust to them quickly. Weather is constantly changing and thus, selling options in weather markets can get dicey, especially for beginners.
Many old time traders favor the "Wall Street Journal Rule." If a commodities story makes the front page of the Wall Street Journal, it's time to fade the story. It's not a guaranteed strategy, of course. As a rule, however, fade the news. Selling options against the hype can be a good way to get big premiums.
- 6. Leg out of Credit Spreads: ( Next step to this thread / Can do in India )
Since the title of this post is not "How to run the most effective, risk adverse option portfolio" I will refrain from preaching the merits of credit spreads and instead offer just a brief tip for increasing your premium from them. A credit spread involves selling an option (or group of options) and then buying another option of lesser value to protect or "cover" your short option. Many sellers of credit spreads simply put them on and let them expire, keeping the "credit" (the difference between the two options) as profit. There is nothing wrong with this and it can be a conservative way to build a portfolio.
However, to squeeze a bit more profit out of your credit spread - try this:
Sell your protection early. Once the short options in your credit spread have decayed by 70-80-90%, the risk in them drops accordingly. This can be a good time to sell your protective option(s) back to the market. Obviously, they will have decayed as well. However, you will recapture some of the premium you paid for them. This can boost your overall return on the spread.
- 7. Use a Pro Floor Trader: ( For beginners and pros )
Option trading on commodities is one investment vehicle where using a floor trader in the pit can still offer you an advantage. Limit orders placed on commodities options through electronic markets can often sit unless a trade actually takes place that "triggers" a fill. In other words, it has to be filled. Floor orders are actively worked by brokers. And if your limit order does not get filled, a floor broker can give you an "active" bid/ask - something that does not always show up on an electronic screen. This is especially true in placing larger orders which floor brokers are very motivated to fill. A good floor broker can sometimes work the order for a better fill. More importantly, they can sometimes get filled on a ticket that might be overlooked in the electronic market.
- A final word:
Collecting the biggest premiums is not necessarily always congruent with having the best return at year's end. To successfully manage your option selling portfolio, you must balance premium collection with responsible risk management. Each of the items listed above can indeed boost your premiums. However each also comes with it's own unique risk of implementing it. Any one of these methods will not be right for every situation. These are a list of strategies and tools you can use. How you apply them will determine your ultimate performance.
Take care and trade that strategies wisely !
DanPickUp
Today I will post here different ways to sell premium. I am clear, that some of the ways are more risky than other ones. I am also clear,that some brokers in the world do not allow some of the ways, which are explained here. Even then : As option traders it is good to know different ways to collect premium.
VERY IMPORTANT : Do read the final word at the end of the post !
--- 7 Ways to Collect Higher Option Premiums ---
- 1. Sell Naked: ( Not for beginners )
Spreading has it's merits. But for pure premium collection, there is no way to get bigger premiums and realize them faster than selling naked. While the word conjures up images of being "exposed" and thus discourages many investors from exploring it, naked option selling can be done responsibly and effectively. While risk must sometimes be managed a bit more closely than "covered" risk, you are doing yourself and your portfolio a disservice if you do not consider selling naked in at least some situations. It's the power play, the strong side sweep, the right hook in an option seller's arsenal.
- 2. Sell Strangles: ( For beginners and pros / Can do in India )
Selling strangles is for many a favorite option selling strategy. While not ideal for hard trending markets or breakout moves, selling strangles (selling a put and a call in the same market) can be an amazingly versatile strategy. It can be deployed in a wide variety of market conditions and has a magical effect on boosting your premium: Doubling your premium collected while reducing your margin requirement (as a percentage of premium).
For instance, selling the put may bring in $500 premium and carry a $1,000 margin requirement. Selling the call may do the same. But selling them at the same time brings in the same premium but lowers the margin requirement. Thus, selling the put and call together brings a greater return on invested capital. As a bonus, selling a strangle also comes with some built in risk temperance. A move against your call is at least partially offset by gains in your put (and vice versa). Thus a strangle can be a flexible way to build account premium quickly.
- 3. Sell Closer to the Money: ( Not for beginners )
Collecting higher premium, selling closer to the money will increase the premiums you collect. For the risk adverse, it may not be your first choice either. The closer you sell to the money, the better chance for your options to go in the money - a place no option seller wants to be. At the same time, moving a strike or two closer can sometimes make a big difference in the premium you bring in. Especially in markets where deep out of the money strikes are available and fundamentals support your position. For instance, if Coffee is at 1.50 per pound, it probably isn't going to make a big difference from a risk standpoint if you sell a 2.90, 2.80 or 2.70 call. But it could make a noticeable difference in the premium you collect. In this type of situation (all strikes are deep out of the money,) selling the closer strike can make sense.
- 4. Sell more time: ( For beginners and for pros )
In my opinion, this is a more conservative method of collecting higher premiums than #3. It's a fact that the more time left on your option, the higher premium you can collect. The tradeoff is that you have to wait longer for the option to expire. Many traders do not have the patience for this. Others feel that selling more time allows a greater window for something to "happen" in the markets. If you want to reduce the chances of something "happening" to your position, know your fundamentals. Sharp moves can happen in any market. However, they are less likely to happen in markets where fundamentals do not support them. Selling more time can be a slow path to higher returns.
- 5. Sell Volatility - Fade the News: ( Not for beginners )
Its not secret to most any option seller that higher volatility means higher premiums. Volatile markets bring in more speculators who not only drive prices in the underlying, they buy options. This means demand and thus premium for the options goes up. Typically, as an option seller, this will mean opportunities for you. This is not to suggest you should sell in front of runaway, breakout moves. However, a spike in volatility often makes the "ridiculous" strike prices. People (investors are people), tend to get carried away or lose their heads in the excitement of fast moving markets.
As an option seller, you can use these situations to your great advantage. After a spike in volatility can often be a great time to sell options. A good example is after a surprise report. An unexpected number comes out and prices of the commodity in question must adjust to reflect the new numbers. This is often (though not always) done quickly - over a period of 1 to 3 trading sessions. After that, the market has priced the new number and trading resumes as normal.
It is even common for the options to "price in" the most extreme possibility in the first day and then adjust its value lower - even as the price of the underlying continues to move towards it. These can be ideal conditions for collected fat premiums - again, however, only if you know the fundamentals. Other types of volatility surges, such as weather events are more fluid and require more caution. Reports are solid and the market can adjust to them quickly. Weather is constantly changing and thus, selling options in weather markets can get dicey, especially for beginners.
Many old time traders favor the "Wall Street Journal Rule." If a commodities story makes the front page of the Wall Street Journal, it's time to fade the story. It's not a guaranteed strategy, of course. As a rule, however, fade the news. Selling options against the hype can be a good way to get big premiums.
- 6. Leg out of Credit Spreads: ( Next step to this thread / Can do in India )
Since the title of this post is not "How to run the most effective, risk adverse option portfolio" I will refrain from preaching the merits of credit spreads and instead offer just a brief tip for increasing your premium from them. A credit spread involves selling an option (or group of options) and then buying another option of lesser value to protect or "cover" your short option. Many sellers of credit spreads simply put them on and let them expire, keeping the "credit" (the difference between the two options) as profit. There is nothing wrong with this and it can be a conservative way to build a portfolio.
However, to squeeze a bit more profit out of your credit spread - try this:
Sell your protection early. Once the short options in your credit spread have decayed by 70-80-90%, the risk in them drops accordingly. This can be a good time to sell your protective option(s) back to the market. Obviously, they will have decayed as well. However, you will recapture some of the premium you paid for them. This can boost your overall return on the spread.
- 7. Use a Pro Floor Trader: ( For beginners and pros )
Option trading on commodities is one investment vehicle where using a floor trader in the pit can still offer you an advantage. Limit orders placed on commodities options through electronic markets can often sit unless a trade actually takes place that "triggers" a fill. In other words, it has to be filled. Floor orders are actively worked by brokers. And if your limit order does not get filled, a floor broker can give you an "active" bid/ask - something that does not always show up on an electronic screen. This is especially true in placing larger orders which floor brokers are very motivated to fill. A good floor broker can sometimes work the order for a better fill. More importantly, they can sometimes get filled on a ticket that might be overlooked in the electronic market.
- A final word:
Collecting the biggest premiums is not necessarily always congruent with having the best return at year's end. To successfully manage your option selling portfolio, you must balance premium collection with responsible risk management. Each of the items listed above can indeed boost your premiums. However each also comes with it's own unique risk of implementing it. Any one of these methods will not be right for every situation. These are a list of strategies and tools you can use. How you apply them will determine your ultimate performance.
Take care and trade that strategies wisely !
DanPickUp
Last edited:
:thumb: wonderfullllllllllll and hats of to u :thumb: Danpickup
hi dan,
first time in traderji, i gone through with such a valuable insight for a SERIOUS option trader.
your points are well taken and appreciated by many option traders.
if i initiate a CREDIT SPREAD, do i get benefit of lower margin as risk is defined.
kindly give the name of your option broker .
:clap::clap: alpesh---------
Hi alpesh
Margin lowers when reducing your risk curve. Check with your broker, how he calculates his margin. In India it is different than in other countries in the world. That is why I wrote :
"I am also clear,that some brokers in the world do not allow some of the ways, which are explained here."
If you read through the thread, you will find enough information about what you can do in India and what is not really possible.
My brokers at the moment are Farr Financial and MFGlobal in the United States.
Take care
DanPickUp
Margin lowers when reducing your risk curve. Check with your broker, how he calculates his margin. In India it is different than in other countries in the world. That is why I wrote :
"I am also clear,that some brokers in the world do not allow some of the ways, which are explained here."
If you read through the thread, you will find enough information about what you can do in India and what is not really possible.
My brokers at the moment are Farr Financial and MFGlobal in the United States.
Take care
DanPickUp
Example of the same
1. First in decline manner buy 250 nifty bees suppose ur average price for nifty bees comes at 500 means u have bought nifty at 5000.
2. After buying nifty bees sell a call of next month higher than ur average cost say of 5100 or 5000 in case of 5100 u may get 80 or 90 rs premium
3. Now say at the end of the month if nifty is 5300 nifyty bees will be 530 so u will have profit of rs 30 per nifty bees i.e 30*500=15000 and say u sold call of 5100 so call price will be 200 i.e 5100-5300=200 so loss of rs. 200*50=10000 but u will gain say conservatively 80 rs premium i.e 80*50= 4000
Summary
1. Profit of Rs 30 per nifty bees = 15000
2. Loss on call 200 per call= 10000
3. Profit on premium 4000
Net Profit 9000
Now this profit is at 5300 level profit may be up or down according to market
I will also disclose risk with it
this strategy is best for the rangebound market when the market is upwards u may gain only premium but then also return is very good if u calculate on investment
This strategy works only when the nifty i.e nifty bees is above ur average cost. if the nifty goes down ur average it is very risky to do this strategy
At last i would say in this strategy profit would be somewhat cap in upward market loss would be reduced in downward market and best in rangebound market
Members pls share ur views on the same
1. First in decline manner buy 250 nifty bees suppose ur average price for nifty bees comes at 500 means u have bought nifty at 5000.
2. After buying nifty bees sell a call of next month higher than ur average cost say of 5100 or 5000 in case of 5100 u may get 80 or 90 rs premium
3. Now say at the end of the month if nifty is 5300 nifyty bees will be 530 so u will have profit of rs 30 per nifty bees i.e 30*500=15000 and say u sold call of 5100 so call price will be 200 i.e 5100-5300=200 so loss of rs. 200*50=10000 but u will gain say conservatively 80 rs premium i.e 80*50= 4000
Summary
1. Profit of Rs 30 per nifty bees = 15000
2. Loss on call 200 per call= 10000
3. Profit on premium 4000
Net Profit 9000
Now this profit is at 5300 level profit may be up or down according to market
I will also disclose risk with it
this strategy is best for the rangebound market when the market is upwards u may gain only premium but then also return is very good if u calculate on investment
This strategy works only when the nifty i.e nifty bees is above ur average cost. if the nifty goes down ur average it is very risky to do this strategy
At last i would say in this strategy profit would be somewhat cap in upward market loss would be reduced in downward market and best in rangebound market
Members pls share ur views on the same
Keeping the risk and Margin required for this, I am not for it.
I do similar strategy Selling Call/put pair and putting stop loss total of it
The loss is minimum if discipline, Read JV thread .Picking Nickles.. in from of Stream..
It will give you same kind of results or better in range market with less risk and margin.
Thanks
Kaps
I do similar strategy Selling Call/put pair and putting stop loss total of it
The loss is minimum if discipline, Read JV thread .Picking Nickles.. in from of Stream..
It will give you same kind of results or better in range market with less risk and margin.
Thanks
Kaps
Thanks for posting reply
Dear selling call and put can be very effective in range bound market but if the market moves in one direction say upwards it will have huge loss. if u keep stoploss i think the profit made in opposite call will be equal to loss.this is my view it can be wrong.
If possible pls suggest me a strategy which u r doing currently i will try one paper made lets c what works out better.....
Its just a discussion decision can be taken according to own wish
Thanks
Dear selling call and put can be very effective in range bound market but if the market moves in one direction say upwards it will have huge loss. if u keep stoploss i think the profit made in opposite call will be equal to loss.this is my view it can be wrong.
If possible pls suggest me a strategy which u r doing currently i will try one paper made lets c what works out better.....
Its just a discussion decision can be taken according to own wish
Thanks
Hi,
I have formed a strategy pls guide me whether i should execute it and what would be stoploss if market breaks out on one side
Sell Sep 2010 5200 PE @37(Closing-18-08-2010)
Sell Sep 2010 5600 PE @54(Closing-18-08-2010)
Safe between 5109 and 5691 on expiry.
Sir pls tell me whether i should execute and in between exprity if market breaks out on any direction where should i keep a stoploss.
Waiting for ur reply.
Thanking
Nirmit
I have formed a strategy pls guide me whether i should execute it and what would be stoploss if market breaks out on one side
Sell Sep 2010 5200 PE @37(Closing-18-08-2010)
Sell Sep 2010 5600 PE @54(Closing-18-08-2010)
Safe between 5109 and 5691 on expiry.
Sir pls tell me whether i should execute and in between exprity if market breaks out on any direction where should i keep a stoploss.
Waiting for ur reply.
Thanking
Nirmit
Hi varun.varma
Welcome in the land of smiles ( Usually Thailand, but not in this case )
Thanks to mention this subject.
You asked for a comment, here the journey goes :
Crash 1987. That was the first thought when I was reading your post about volatility smiles. In the crash 1987, you even could make money with some calls. Sounds impossible, but it happen. The reason for such a phenomenon was the implied volatility. Implied volatility, as we know or learned, has an impact on the price of an option. Low IV means the option is cheap and high IV means, the option becomes expensive.
As you already pointed out and explained a lot, I will explain on the subject by giving a deeper look at the work of the option dealers or market makers directly on the exchange.
In the real market, we have different participant. We have a seller of an option and we have on the other hand a buyer of this option. If they are not there, there will be the option dealer on the exchange or also called the market maker. He is obliged
to fill any orders if there are no participants in the market. It will be his risk.
As a professional option traders, they are confronted with different risk. I will divide them here in three risk.
A = Input-risk
B = Guess-risk
C = Practical-risk
A is adapted to the options greeks. If you want to sell and they, as options dealer at the exchange, which have to give the guarantee at any time to all of us, that they will take or sell our options, under what ever circumstances, they will calculate the price of the options compare to the given market risk, means market circumstances. If they are normal, they will use the normal formula from Black-Scholes or the Cox-Ross-Rubinstein formula. This have been the rules, in a nutshell explained, until the crash of 1987.
B is adapted to the " I guess " risk. The formulas are just mathematical calculations. They have nothing to do with any reality. They are abstract. In reality, not everything goes on normal all the time. There is always a change or some thing going on and this they will price in to the options.
C is adapted to the practical risk they have at the exchange. There are rules and they have to accept them. If they are not able, to fill up this rules, they will be gone or they just can not deal.
A + C : The input risk and the practical risk do not have much impact of the implied volatility or price of the option. They are given and they are accepted by the market participants.
B is the key to this question. The " guess " risk has the most and heaviest impact on the volatility and so to the price of any option. The expectations, the option price makers have, are first time seen in the vola smile after the crash of 1987.
The option dealers on the exchanges became panic during the crash of 1987. As they automatically had and still today have to give the guarantee, that they will execute any trade, no question if sell or buy, they then passed there risk through immense option prices to the buyers and sellers of this options. That was there protection against any losses, which may could occur to them during this crises. They want to make money under any circumstances and that is what outsiders have to accept and to understand. If they ignore that, they never will be successful option traders. Those dealers on the exchanges finally make the rules !
Since then, the " guess " impact has become more valuable and real in option pricing. Today, the Black-Scholes formula is no more so important. Option market participants today bear in mind, that a crash any time can occur and this is priced in to the options today, specially in puts and in far out of the money options.
Out of the money options have more " guess risk " implied than at the money options. As the market has more time to do some thing unexpected until this options expire or are at the money, the market makers have to adjust there risk to this possibility.
Finally : The crash from 1987 was the turning point for the actual option pricing. Since this crash, the so called option smile exist.
Have a nice evening.
DanPickUp
Welcome in the land of smiles ( Usually Thailand, but not in this case )
Thanks to mention this subject.
You asked for a comment, here the journey goes :
Crash 1987. That was the first thought when I was reading your post about volatility smiles. In the crash 1987, you even could make money with some calls. Sounds impossible, but it happen. The reason for such a phenomenon was the implied volatility. Implied volatility, as we know or learned, has an impact on the price of an option. Low IV means the option is cheap and high IV means, the option becomes expensive.
As you already pointed out and explained a lot, I will explain on the subject by giving a deeper look at the work of the option dealers or market makers directly on the exchange.
In the real market, we have different participant. We have a seller of an option and we have on the other hand a buyer of this option. If they are not there, there will be the option dealer on the exchange or also called the market maker. He is obliged
to fill any orders if there are no participants in the market. It will be his risk.
As a professional option traders, they are confronted with different risk. I will divide them here in three risk.
A = Input-risk
B = Guess-risk
C = Practical-risk
A is adapted to the options greeks. If you want to sell and they, as options dealer at the exchange, which have to give the guarantee at any time to all of us, that they will take or sell our options, under what ever circumstances, they will calculate the price of the options compare to the given market risk, means market circumstances. If they are normal, they will use the normal formula from Black-Scholes or the Cox-Ross-Rubinstein formula. This have been the rules, in a nutshell explained, until the crash of 1987.
B is adapted to the " I guess " risk. The formulas are just mathematical calculations. They have nothing to do with any reality. They are abstract. In reality, not everything goes on normal all the time. There is always a change or some thing going on and this they will price in to the options.
C is adapted to the practical risk they have at the exchange. There are rules and they have to accept them. If they are not able, to fill up this rules, they will be gone or they just can not deal.
A + C : The input risk and the practical risk do not have much impact of the implied volatility or price of the option. They are given and they are accepted by the market participants.
B is the key to this question. The " guess " risk has the most and heaviest impact on the volatility and so to the price of any option. The expectations, the option price makers have, are first time seen in the vola smile after the crash of 1987.
The option dealers on the exchanges became panic during the crash of 1987. As they automatically had and still today have to give the guarantee, that they will execute any trade, no question if sell or buy, they then passed there risk through immense option prices to the buyers and sellers of this options. That was there protection against any losses, which may could occur to them during this crises. They want to make money under any circumstances and that is what outsiders have to accept and to understand. If they ignore that, they never will be successful option traders. Those dealers on the exchanges finally make the rules !
Since then, the " guess " impact has become more valuable and real in option pricing. Today, the Black-Scholes formula is no more so important. Option market participants today bear in mind, that a crash any time can occur and this is priced in to the options today, specially in puts and in far out of the money options.
Out of the money options have more " guess risk " implied than at the money options. As the market has more time to do some thing unexpected until this options expire or are at the money, the market makers have to adjust there risk to this possibility.
Finally : The crash from 1987 was the turning point for the actual option pricing. Since this crash, the so called option smile exist.
Have a nice evening.
DanPickUp
Last edited:
- Status
| Thread starter | Similar threads | Forum | Replies | Date |
|---|---|---|---|---|
| O | Take low risk, earn low profit | Forex | 0 | |
| R | How do you follow risk management strategy? | General Trading & Investing Chat | 4 | |
| O | How do you lower your trading risk? | Forex | 9 | |
| J | Low Risk Nifty Options Strategy (Risk < Rs.1500) | Options | 3 | |
| P | Low Risk Options Trading Strategy | Options | 7 |
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