Options trading can help you achieve a diverse array of financial objectives. From hedging risk to speculating on future price movements, trading can be a valuable tool for engaging the world’s capital markets.
Selling options, however, is a unique undertaking that requires a comprehensive understanding of the process. Although it may be suitable for some, it’s certainly not a pursuit that is a good fit for everyone. Read on to discover whether joining the selling side of the options markets is a viable way of achieving your monetary goals.
When Is Selling Options a Good Idea?
Before deciding whether or not selling options is for you, it is important to first understand what the undertaking entails. When you sell, or “write,” an options contract, you are legally obligated to satisfy the terms of the call or put. Although this can be a profitable strategy, writing options is a serious business that requires you to assume theoretically unlimited risk.
For instance, if you sell (or write) one call option of Chicago Mercantile Exchange (CME) 2021 December gold (GC) with a strike of $1700.00, you are guaranteeing the transaction. This means that the buyer has the right, but not the obligation, to purchase one lot of December gold at $1700.00 by contract expiry. When writing (or selling) the call, here’s what happens:
- You become legally bound by the terms of the contract.
- You are immediately credited with the option’s premium.
- If GC fails to rally above $1700.00 by expiry, you profit from collecting the premium. If GC rallies above $1700.00 at expiry, you are required to pay the difference between the current market price and the strike. This may exceed your revenue from the premium.
The uncapped exposure of selling options scares many traders away from the strategy, and rightfully so. Crushing losses may be realized from erratic markets, as we saw during the COVID-19 panic of March 2020. Despite the risk, there are times when selling options makes good sense.
Steady Cash Flows
At one time or another, everyone needs money. Selling options is one way to generate steady cash flows in exchange for assumed risk. Let’s say that you decide to sell that CME December gold call from $1700.00. The contract is trading at-the-money (ATM) and commands a $15.00 premium. Given the contract size of 100 troy ounces, your account is credited $1500.00 ($15.00 x 100 ounces). Upon contract expiry or the position being liquidated, a portion or all of the $1500.00 may become realized profit. Although the trade’s final profitability will depend upon price action, selling the option is one way to address a periodic need for cash.
Strategic Applications
The practice of options writing is incorporated into many professional trading strategies. Here are three of the most popular:
- Bull call spreads: Under a bull call spread, the trader simultaneously buys and sells calls in the same contract (with the same congruent underlying assets and expiration dates). The written calls have a higher strike price than the purchased calls, thereby securing bullish market exposure with a reduced up-front premium cost.
- Bear put spreads: A bear put spread involves the simultaneous buying and selling of put options on the same contract. The written puts are at a lower price than the purchased calls, thereby securing bearish market exposure at a reduced up-front premium cost.
- Protective collars: The protective collar strategy is executed by purchasing out-of-the-money (OTM) put options and selling OTM call options in the same contract. This strategy can act as an insurance policy for traders and investors already holding profitable positions in the option’s underlying assets.
In practice, there are a vast number of strategies that integrate selling options into a comprehensive trading plan. Due to the complexity of options pricing and the intricacies of market behavior, many traders rely on the expertise of their broker for guidance.
Capitalize on the Potential of Options with Daniels Trading
When you’re ready to pursue your financial goals in the options market, a conversation with a Daniels Trading broker is a great place to start. Click here to schedule your free 0ne-on-one consultation today!
