Selling deep otm options trading
Some strategies like this include covered call writing and using vertical spreads. When profiting from a directional move, we buy far out-in-time options so the decay of time is minimal. We then trade options that are somewhere from at-the-money to in-the-money. If volatility change is probable, it's always smart to error by going deeper in-the-money.
Of course if you are trying to profit from time decay and a directional move, a near-term at-the-money or in-the-money strategy that incorporates selling an option may be in or-der, but realize you are trying to manage two variables which actually creates four possible outcomes to think about.
Okay, with options preselected and while we're monitoring our hot list, we look for a set-up -- like a breakout -- that correlates to some kind of entry point.
Entry signals we look for may include a gap down or a gap up on higher-than-average volume; an established trend with a small swing away from the trend followed by a big swing back into the trend; a "Short-Term Trend-Following" setup; or a variety of other signals.
Of course, we always look for follow-through to confirm the signal we're going to enter a trade on. If there is no follow-through and the price moves opposite of what we expect , we abandon the trade. Assuming we've been given a valid entry signal with follow-through, we enter the trade and then plan our exit. And, in fact, my exit strategy is always in place before I ever en-ter a trade.
Here's my general rule for our technical exit: So whatever signal produced the entry should also be the exit. Said another way, I leave through the same door I came in through. This keeps it simple. Of these five steps I've shared with you, I believe Step 5 may be the most important of them all. How we exit a trade and the discipline we use to make our exits could make the difference between small gains and large gains, small losses and big losses.
So those are the five basic steps I use to trade stock options short to medium term. If you'd like to learn my strategies more in-depth, you might want to consider checking out the Home Study Course with complimentary member site access. What I haven't found in this article is the Stop Loss provisions un-mentioned. Are stops NOT desirable in such trades?
I apologize that I didn't explicitly use the words stop loss in my blog post. To me, they are implied. And, in the post I wrote above, I stayed very high level for fear I might have published a whole other home study course as a guest blogger.
When I teach open position management, I teach that, in parallel, you must manage your technical stops, time stops and your stop losses. At a minimum, a stop loss provision will allow you to stay true to the money management limits you've extended yourself.
If one enters a position on a price threshold crossing, they would want to exit on one as well. Specifically, an exit on a price threshold crossing could very much be implemented using a stop loss.
So, I contend that you and I are on the same page after all. My lack of being explicit on the use of stop losses in exits may have caused you to perceive otherwise. You do need to evaluate various profit-loss scenarios and understand how the outcomes of these scenarios play within your money management rules.
In the case of a covered call writing strategy, you are profiting if the underlying stock moves horizontally thanks to time decay. And, you are profiting if the underlying stock appreciates thanks to time decay and the increase of intrinsic value to a point. To keep from getting called out with an in-the-money option, and still take advantage of time decay, we can always buy back our option right before expiration.
It's good to note as well that the time value component of an option premium is at its highest when the option is at-the-money. That means an option that is at-the-money will see the biggest change in price due to any number of variables changing including underlying stock price, time ticking away, and volatility.
Although selling options at-the-money may seem to be the most profitable move, because of the option premium being so responsive to many different variables, it's also the most unpredictable outcome; the confidence we'll realize full profits goes down. There are some details not clearly defined.
Deep in-the money option will be exercised, not expire worthless. If it is a covered call, your stock will be called away. Some profit-loss accounting required for this strategy, isn't it? I noticed that also. I think he meant "out of the money" if calls and in the money only if puts? It could work with either option type actually. It depends on your intention. What's most important is thinking through your end game with your preselected option, ahead of time and from that planning exactly what exit signals you're going to act on.
I will exit this position two days before expiration. How to find low risk entry points in any market. Once having found the trade, Trading Options will be a losing game without them!!! Hi Bill- I apologize that I didn't explicitly use the words stop loss in my blog post. Unquote Deep in-the money option will be exercised, not expire worthless. Hi Tom- It could work with either option type actually. Perhaps in one of my future articles we will go over this, as well as the more practical version of this strategy, the put ratio.
Let us turn our attention to the composition of a Call Ratio Spread. The set up is done in such a way that we purchase a single contract at a lower strike price, and sell two contacts at a higher strike. To visualize it in our minds, think of a stock trading at 47 and the 50 level being a really strong level of resistance. Buying an OTM Bull Call spread involving a long lower 49 strike price call and selling the higher 50 strike price call would closely match what this Call Ratio Spread is; with the one exception: The figure below gives a visual.
This net credit should be viewed as a minimum profit. The calculation for Maximum Profit is a bit more elaborate because it takes into consideration the strike price spread. The formula for Max P is the number of long contracts multiplied by the strike price difference plus the net credit. The maximum profit takes place at the expiry if both short 50 calls expire worthless, and the long call is closed for profit because it is in-the-money; specifically if XYZ was Nevertheless, as attractive as the max profit seems, keep in mind that the selling of the two calls gives the obligation to sell the stock at the 50 strike price.
Only one of those two sold calls is covered; the second sold 50 call is uncovered, exposing the trader to theoretically unlimited risk.
If the price were to rally from 47 up and beyond 50, which abnormal moves do happen, then action needs to be taken. The goal was to see the stock price close below Hence the stock could go slightly up, from 47 to Any strong bullish move above 50 could result in losses. Also, if a trader is not approved for trading uncovered calls then most likely this type of trade will get rejected by the broker even before it gets executed. This advanced option strategy is not suitable for novice traders for it requires the approval for trading uncovered calls.
One of the ways that the professionals utilize this strategy is by trading it with index options that are European style. Fluctuations in an index historically have been NOT as volatile as in individual stocks, especially pharmaceuticals.
Keep in mind that with options education, there is always another higher level to learn about.