Video Lesson – How To Pick The Right Option To Sell
Michael Gross discusses How To Pick The Right Option To Sell
Hi, this is Michael Gross, co-author of McGraw-Hill’s The Complete Guide to Option Selling and also Director of Research here at OptionSellers.com. I’m here with your bi-monthly option seller video lesson. This week’s lesson is What Options Should I Sell? What you’re going to find in this week’s lesson is kind of a compilation of some of the other lessons that we’ve given, but kind of rolled into one answer to this particular question, which is one we get often. Before we get started, if you would like a more complete answer to this question along with other details about commodity option selling and how you can make it a core component of your overall portfolio, I recommend The Complete Guide to Option Selling: Third Edition. It is available on our website right now at a 40% discount off of cover price. You can get it at www.OptionSellers.com/Book.
In these videos and our book and some of our guides we publish we talk a lot about different option strategies, we talk a lot about why you sell options, different things you can look for, and the underlying commodities in which you’re selling these options on. One of probably the basic question that a lot of people have is this one. “When it comes down to it, what options should I sell? How do I go about picking an option that’s going to have the highest probabilities of expiring worthless in a market that I’m comfortable trading.” We’re going to talk about the guidelines today. There is no one single answer, there’s no one best option you can sell, but there are guidelines and we’re going to cover those guidelines today for you as a new commodity option seller. Let’s get started.
As far as answering what option should I sell or what’s the best option for me to sell or how do I go about picking an option, selecting an option… there’s really 5 main guidelines that we recommend you go by. They are the 5 we go by when we are selecting options for our managed portfolios. If you’re trading on your own, you’d probably be well served to use them, as well. The first one, and it’s one you’ve heard us preach often, you use the fundamentals to determine which underlying commodity you’re going to sell your options on. This is where you start. You start by selecting the market. You select the market not based on what the technicals say, not based on what the newspaper says, but you select it based on what the long-term fundamentals are. As you know from our previous lessons, that’s supply and demand, that’s where supply and demand is expected to be 3, 6, 9 months down the road, and we’ve covered different ways you can look into how to do this or the type of factors you look at. The important thing to remember, however, is you want to look at and know the long-term fundamentals, develop a bullish or bearish fundamental bias toward that market, and sometimes it’s a neutral bias in which case you could ride both sides of the market, but the important thing is to start with your fundamentals. That’s how you select the market.
What’s the second step? This is another key concept you’ll see in many of our educational materials. You always want to be selling deep out-of-the-money options. Why? Of course, it’s the whole reason we sell options. We don’t want to get into the game of picking short-term market direction. It’s too difficult, especially in commodities where you’re dealing with that extra leverage. You want to be focused on long-term direction of the market. That’s why you use your fundamentals. Once you have that, you want to be adding that extra step of putting high odds in your favor and that’s by selling deep out-of-the-money options. That allows the market to fluctuate over the short-term without being stopped out and your position can be far above or far below the fray. You’ll remember that these two concepts together represent our FUDOM method of selling options… FUndamental Deep Out of the Money. It’s what our whole portfolio program is based on. That’s why they’re numbered one and two here. When you’re selecting how to sell an option.
Number three fits right into this. It’s actually a second part of number two. Trade time for distance. Really, what that means is if you’re going to incorporate step number two, which is sell deep out-of-the-money, if you want to get any big premiums for your options or even decent premium for a return on your money, you’re going to have to trade something or sacrifice something to do that. That means selling with more time. A lot of books, manuals, courses will tell you to sell options with only 30 days left on them, but that’s usually not a good idea if you want to trade the markets long-term and stay out of the fray of short-term fluctuations. If you sell options with 3, 4, 5 months of time left on them, it may seem like a lot of time, but you can sell options that are very deep out-of-the-money and typically be far above or far below where the market is trading and not be affected by short-term market fluctuations up or down. Granted, you might have to stay in them a little bit longer, but one thing to keep in mind is if you’re right and the market is moving favorably, those options will be decaying and often times you don’t have to stay in them all the way through expiration. You can often times buy out of them early. Sometimes that’s a month early, sometimes it might be 2 or 3 months early depending on how much time you have left on your option. It’s something to keep in mind.
Actually, we’re going to go up. If you got the first 3, we are going to do the last 2 up here where you can see them. Now, we get some comments on our book every once in a while that are like, “Ah, you guys, you downplay volatility, you don’t use it a lot.” That wasn’t really our intention, it’s just that so many people focus purely on volatility that they’re discarding some of these other factors that we feel are more important. Volatility should be a consideration when you’re selecting the right option to sell. Obviously, as an option seller, you’re going to do better if there’s higher volatility in that market. It doesn’t have to be super volatile where it’s flying all over the place, but you like some volatility there because that’s what bumps those premiums up. So, you’re going to want to look at your volatility, to some people the Delta is important and it is something we look at when we’re selecting trades. It’s not the most important factor we look at because we’re trading a different kind of way; we’re trading longer-term fundamentally. Volatility definitely has to be a consideration though when you are selecting a market and selecting option premium because that’s going to determine how far out-of-the-money you can write and it’s going to determine what kind of premium you get, so it is something to consider.
The fifth thing that will be important to you… technical indicators. This is something else we don’t talk a lot about, but you will see it in some of our materials. We also mention it in the book. Technicals can be a way to time the trades. We don’t select markets based on technicals, and if you’re trading commodities in this manner where you’re selling option premium is probably not the best way to trade, either. In timing your trade in a market you’ve already selected, you’ve already selected your strike, and now you’re looking for the right entry point, technical indicators can often be a good way to time that trade or help you time that trade, sometimes get a little better premium on it. It doesn’t matter which one. Everyone has their own technical indicators that they like. We do, as well. Some apply better to different commodity markets than others but, as a fifth step, technicals would probably be your last step in helping you decide where to enter your position.
If you follow these 5 guidelines, you will be in pretty good shape when it comes to selecting commodity options. It’s probably a good checklist to go down if you’re looking to take premium in any market. It’s certainly the one we use. It’s one we apply to all of the trades that we do on behalf of our investors. If you’d like more information on becoming one of our investors or joining our private client group, you can request your free Option Sellers Discovery Kit for high net-worth investors. We’ll tell you a lot about our different programs we have available for our managed portfolios through our private client group. It also has a 30 minute DVD of James Cordier’s private seminar for high net-worth investors on option selling. You can get that at www.OptionSellers.com/Discovery . I hope you found this week’s lesson helpful and we’ll see you again in two weeks. Thank you.