Why Sell Options?

The Top 10 Advantages

TOP 10 ADVANTAGES

OF SELLING OPTIONS


  • Confidence of knowing you are now trading With the Percentages.
  • Comfort in the knowledge that time is now your powerful ally.
  • Relief from no longer having to guess market direction or time your trade perfectly.
  • Freedom from the chains of the stock market and into a real diversifier.
  • Satisfaction from the potential for outsized returns
  • Easeof Taking profits. Options simply expire.
  • Consistency from targeting small gains over and over.
  • Peace of mind in a strategy that can be effective in nearly ANY kind of market.
  • Security of investing in hard commodities that will always have a value, not a piece of paper.
  • Efficiency in keeping more of what you earn – Option Selling is a tax friendly strategy

In addition to being Founder of OptionSellers.com, I have been trading options and futures contracts for the past 30 years. If you’ve already read my story, you know it took me nearly 20 of those years to realize that selling options was, in my opinion and not without risk, the single most productive approach I’d ever found to build equity in an account. That being said, I can tell you that selling options is not for everyone.

…selling options was, in my opinion and not without risk, the single most productive approach I’d ever found to build equity in an account.

If you like fast action and big thrills, this is not the place for you. If you think there is such a thing as a risk free investment, this is definitely not the place for you. Option Selling is not perfect and does have some disadvantages that you should explore when deciding if the strategy is right for you.

However, if you are an intelligent, rational, high net worth individual who is looking for an investment approach that targets high returns with reasonable risks, has relatively high odds of success on each individual trade and requires a semi passive, lower stress type of management style, option selling could be right for you. To learn the complete strategy of option selling and how to use it in your portfolio – I recommend our third book The Complete Guide to Option Selling, 3rd Edition (McGraw Hill 2014). For a more introductory outline of the strategy, our free no obligation booklet – The Option Selling Solution will do the trick for you.

While risk always plays a role in options trading, option sellers enjoy advantages not found in any other style of investing.

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The Top Ten Advantages of Selling Options (for high net worth Investors)

1. Trading with the Odds

This is one of the biggest advantages of selling options. The 80% of options held through expiration figure grabs people’s attention of course. Chat room “option geniuses” may argue this figure’s relevance. But few will argue an option sellers advantage over an option buyer. And even fewer are actual portfolio managers.

If you are interested in this figure and its origins, there is a whole section on it in our newest book The Complete Guide to Option Selling – 3rd Edition (McGraw Hill).

A black jack dealer in Vegas only has a tiny edge over any particular player at his table. Yet if players sit there long enough, the dealer will eventually get all of their money. This exemplifies the power of using applied odds over time. The strategy of selling options is, at its core, a strategy of using applied odds over time.

The fact of the matter is, you can choose options with a 90, 95 even 99% chance of expiring worthless. When is the last time you got those kinds of odds buying a stock? While risk of loss is always present, as an option seller, you gain the Confidence of knowing you are now trading with the percentages. The fact that most investors don’t know how to harness these odds is not your problem. Let it be theirs.

roulette wheel
“The strategy of selling options is, at its core, a strategy of using applied odds over time.”

2. Time is on your Side

When selling (or writing) an option, time value works for you instead of against you. That means that whatever else is going on in the underlying market, you enjoy the comfort of knowing that the unwavering hands of Father Time are always working in your favor.

When you sell an option, the buyer of the option pays you a premium for that option. If you sell an out of the money option, the entire value of that option is in time value. As time passes, all other things remaining constant, the option will gradually lose its value. This is called Time Decay and it’s one of the main reasons selling options can be so effective. It is for this reason that OptionSellers.com pursues a strategy of selling deep out of the money options in client portfolios.

rate of decay

The closer an option gets to expiration, the faster its rate of time decay.

The graph above illustrates the principle of time decay and its acceleration as expiration draws near. An option is considered a “wasting asset.” Time value erodes as each day passes, accelerating as the option’s expiration nears. This is referred to as time-decay. If the underlying contract’s price does not move to the option’s strike price by expiration, the option will have no value left and expire worthless and the option seller will keep the premium. Of course, as in any trading, a large move in the underlying may result in a loss. This is the concept on which our entire portfolio strategy is based. Notice that the value decays the fastest during the last 30-60 days of the option’s life.

Learn How YOU can use time value to build a custom option selling portfolio – the right way.

Get your Free Copy of our training manual for high net worth investors – The Option Selling Solution HERE NOW.


3. No More Trying to Guess Market Direction

No matter what they say, nobody knows what any market is going to do, especially on a short-term basis. However, do enough homework, and it is sometimes possible to make a fairly accurate projection of where prices will not go on a longer term basis. By selling deep out of the money options, you avoid the game of trying to predict where prices will go today, tomorrow or next week. Instead you are only projecting where you think prices won’t go. For instance, if you are bullish the natural gas market, you might sell a deep out of the money put option. In this case, the market can move up, stay the same or even move down, as long as it is above your strike price upon expiration, you will still take your full profit.

As an Option Seller, you accept the fact that you cannot predict the future. You free yourself from the “need” for the market to move in a particular direction. You are satisfied to simply “bet” against the unlikely events and then take a payment for your efforts – over and over again. While there is still risk in this strategy, you have the ability to profit regardless of which direction the market is moving, or even if it does not move at all.

Market Direction
“Avoid the game of trying to predict where prices will go today, tomorrow or next week. The purpose of analyzing a market now simply becomes a practice of picking a far away point where it won’t go.”

4. No More Perfect Trade Timing Needed

When investing in the markets, the daily stresses of trading can wear on a person. Where to get in, where to get out, why is it moving, why is it not moving? It can lead to emotional decision making. Many of our clients tell us that selling deep out of the money options removes much of the stress and emotional decision making that is common in futures (or equities) trading. When buying a stock or futures contract, when you enter your position is just as important as what you are buying. In selling deep out of the money options, the values typically aren’t moving as quickly. The fact that they are deep out of the money can mean that daily fluctuations in the underlying market may not have a large impact on the price of the option. Thus your timing becomes less important.

Although all futures trading carries some degree of risk, done correctly, option selling can place your position in the market far enough away that short term swings in the market may not dramatically affect your position. This not only gives you staying power but allows you to focus on longer term market fundamentals. Relief from this decision means less stress for you.

But there is a side bonus to this too.


5. Taking Profits

One of the hardest parts of futures or any trading is deciding when to take profits. With option selling, if the market behaves favorably towards your position, you are relieved from the responsibility of making this decision. As time value decays your option, the market will gradually take profits for you.

Upon expiration, if the option is still out of the money (has not reached your strike price), the entire premium for which you sold the option will be in your account. At this time, your position automatically closes out.

However, you reserve the right to close out your short option position at any time prior to expiration as well – either as a loss limiting measure, or as a profit taking move. It’s a personal choice. In regard to taking a profit, some of the investors we’ve worked with find that it can be easier and require less effort to simply let the market “do it for them.”

Of course no “safe” trading system has ever been devised and no one can guarantee profits or freedom from loss.


6. Discover Real Diversification

A commodity option selling portfolio offers a true diversifier – a freedom that is rare in the financial markets. Option Selling can be the key to the chains that bind you to your overweighted stock portfolio. Now you may argue that either

  • a. I already own commodities in my portfolio… -or-
  • b. Commodities sometimes track the stock market – they’re not that diversified

Both of these statements could be true. And they would also both be irrelevant. For a commodities option selling portfolio can be totally uncorrolated to anything else, even the commodity indexes themselves. Why?

Commodities

Two reasons.

  • 1.Because commodities markets are much less correlated to each other than are stocks. For instance, if you buy shares of Exxon, Apple and Caterpillar and the DOW tanks, chances are your share values are all going down, regardless of how “good” they are. The are all stocks and there are many macro-economic factors that affect all stock prices. To commodity traders, “stocks” are simply one of many futures contracts. On the other hand, if you own contracts of natural gas, silver and soybeans, those are three widely different products with very different fundamentals that affect their price. The price of one has little to do with the price of the other. That gives you broad diversification. But that’s not the biggest reason.
  • 2.Because as an option seller, you can sell puts and/or calls. That means that in addition to having positions in a variety of unrelated markets, you can be long, short or neutral – or all at the same time! As an option seller, you often don’t care what way the market is moving on a net basis. Your only concern is that it does not move sharply against your position in a short period of time. A macro economic event that tanks stocks or moves commodities indexes can be good, bad or neutral to your position as an option seller. An oil shock can have little effect on your position in coffee. Make sense?

7. The Potential for Outsized Returns

If you are purely seeking an investment with some horsepower, this could be reason #1 for you. For while option selling can be “slow and boring” for the action oriented trader, the accumulated premiums and leverage of the futures markets can make them anything but. Stock option sellers take note: This ain’t selling covered calls on your Microsoft. This is option selling on steroids. If you sell a stock option and take a $200 premium, you are generally paying 10 to 20 times that amount in margin to hold that position. In commodities options, you can sell options for

  • a. Much Higher premiums (we target $500 to $700 each)
  • b. Much Lower Margins (generally 1 ½ to 2 times the premium)

Thus a margin for a $500 option premium may only require a $750 to $1,000 margin requirement from you. We’ll let you do the math.

Commodities

Suffice to say, if you get satisfaction from targeting potentially high ROI on your investments and are comfortable with a certain degree of risk, option selling on commodities could be a good choice for you.

Using commodities leverage to your advantage is covered thoroughly in our book The Complete Guide to Option Selling (3rd Edition) on sale in fine bookstores or here now.


8. Consistency

Most forms of trading rely on taking a series of small losses and then waiting for one big gain to not only cover all of those losses and transaction fees – but also produce some kind of net profit on top. In other words, the way many traders are taught to trade is strike out over and over again in the hopes of hitting a home run every once in awhile.

“Keep losses small and let profits run” is the trading mantra of many a guru – and many a trading book. The problem is, while it sounds simple on paper, this approach runs contrary to human nature. Taking losses quick in a losing trade is psychologically difficult for many – especially those of us used to being right and winning. Taking a quick loss in a trade we’ve put a lot of thought and effort into is terribly difficult – especially when we’re convinced we’re right and the move against us is only slight. We’ve been taught since childhood to “stick with it, persevere, stay the course.” That kind of thinking can get you killed in trading. The right thing to do in life or in most any other business or profession is the exact wrong thing to do in a trading account.

“Keep losses small and let profits run” is the trading mantra of many a guru – and many a trading book. The problem is, while it sounds simple on paper, this approach runs contrary to human nature.”

And the only thing more difficult than taking a quick loss? Taking profits! Have you ever had a big winner and then had to decide where to get out? Agonizing, isn’t it? The thing runs in your favor, then comes off the highs and you think “well, that’s it, the next time it approaches that high, I’m out.” But it doesn’t quite get there again, does it? And you keep riding it down, waiting for the next “rally” to get your money. And a big profit turns into a modest one, or worse yet, another loss. The worst thing to be in trading is an optimist.

Option Selling allows you to take the opposite approach – a more “natural” approach in line with human instinct. In option selling, you give up your chance to hit home runs in favor of hitting singles over and over again. Instead of most of your trades being losers with the hope of one big winner, this approach targets having most of your trades coming out winners. While losing trades still have to be managed, the market typically has to make a larger scale move to approach your risk parameters. In other words, the system attempts to make it unlikely short term market “hiccups” will take you out of your trade.

And the best part? No more guessing where to take profits. The market does that for you – automatically when the option expires.

This consistency – having a series of trades winning instead of losing trades- can be not only psychologically beneficial to you, the trader, but give you more focus to act when there is a risk measure to be employed or a new opportunity to capture.

Of course no “safe” trading system has ever been devised and no one can guarantee profits or freedom from loss.


9. Can be Effective in Nearly Any Kind of Market

A major benefit of option selling (and one that makes if a favorite of the high net worth crowd) is that it can be effective in nearly any kind of market conditions. As covered above, this is especially true in commodities, where individual markets tend to move somewhat independently of each other.

If you have a big chunk of your cash in stocks, it’s all good until you hit a market correction, a wave of volatility on some economic or geopolitical event, or an outright bear market.

As an option seller, especially a commodities option seller, you have the ability to be successful in these kinds of markets. While your golf buddies are complaining about the “rough waters” the market is in, you can (potentially) be sailing in a cool breeze. Remember, you’re deep out of the money – way over or way under the market. While this doesn’t make you bulletproof to all market events, it does give you a great deal of flexibility and diversity to deal with what may come along. The end result for you is the peace of mind of knowing your portfolio has the potential to produce no matter what is happening in the financial markets.

Investing in Real Products that will Always Hold Value – Not a piece of paper.**

We all remember 9/11. How about the financial crisis of 2008? Remember Lehman Brothers or Bear Stearns? How about Enron? On the days and weeks those events occurred, when companies and paper became worthless, (or perceived to be worthless), people still woke up and ate their corn flakes and drank their orange juice. They still put gasoline in their cars and drove to work, where they drank their coffee and ate their chocolate doughnut made with wheat, sugar and cocoa. And to comfort themselves, they went home to their nice warm natural gas heated home, got out a pound of ground beef (raised on USDA approved soybean meal) for dinner and retired to their den. Here they retrieved their gold and silver coins they had hidden in the safe and counted them to comfort themselves in the moment. Why? Because they had value. And they feared when they turned on their computer screen tomorrow, all of that paper they had their money in would not.

“Sugar can’t go bankrupt. Soybeans can’t go out of business.”

Does this mean the commodities are always a better investment than stocks? Not at all. One is not necessarily superior to the other. Are we suggesting that stocks are more dangerous or “risky” than commodities? Of course not.

What it does mean is that no matter what goes on in the world, commodities, such as the ones listed above, will always have some kind of demand. And where there is demand there will always be value. It may not always be the same value. But a value nonetheless. A pound of sugar will always be worth something to someone. Same for a barrel of oil or a bushel of wheat.

As a high net worth investor, you are likely already aware of the crucial practice of diversifying your assets. With commodities, you gain an extra feeling of security in knowing you have a component of your assets in investments you can hold in your hand –a lump of silver, a gallon of gas, a bushel of corn – things you can touch, feel, use. No matter what happens in the world, it remains likely that Americans are still going to want breakfast in the morning and dinner at night, fill up the gas tank, stay warm or cool, and feel “safe” with some precious metal in the closet. The same cannot be said for pieces of paper that have names like “Enron” or “Lehman” printed on them.

** This advantage is enjoyed exclusively by investors in commodity futures and options.


10. The Option Sellers Tax Advantage

If you think you pay your “fair share” and then some, commodity option selling could be the right strategy for you. Profits on option selling are taxed on the “60/40” rule – 40% as short term capital gains but 60% at the same rate as dividends. This makes them a favorable investment for those in high tax brackets.

In addition, your end of year taxes on your commodity option selling account are surprisingly simple. You get a straight 1099 (profit/loss) statement and you pay your taxes based on that one figure. No more reconciling each and every trade for the year.

This aspect makes the investment both simple to account for and tax efficient.

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To learn more on how to put these advantages to work for you in the market, request your Free Copy of our Booklet for High Net Worth Investors – “The Option Selling Solution Now”.