Friday, June 12, 2009

The Beauty of Option Selling

I'm not always right in picking exact moments in the market. That's why I really like selling options. You don't always have to have pinpoint precision in your market timing because options also contain a premium for time value and volatility. As time passes and volatility changes, so will the price of the option.

At the beginning of the month, we sold S&P July 900 calls at 56. Our timing was not so good as the market has continued to creep higher. Yet even as the S&P lies more than a point above our entry price, the option price premium has eroded by from 1 to 2 points. We sold the July option instead of the June since we wanted it to still be active when we wrote the end of June Trendsetter Newsletter. Had we sold the June option, the price premium would be eroding even faster and our gains would be greater. If the S&P remains unchanged at 940 through the end of July, we would still win even though our expectation for a lower market price was wrong.

Since Volatility is also an important factor in the pricing of an option, we need to keep a close watch on it. The Size indicator above is our measurement of volatility. When Size is rising, you need to be very careful about selling options. Increasing volatility will cause option prices also to increase even despite eroding time premium. We can see that now the Size figure for the S&P is beginning to reverse indicating that both a decrease in volatility and time will be a positive factor for option sellers

Now might be a good time to consider selling S&P call options. To be safe, sell options out of the money. Often, the index price will need to move a large percentage against you before you lose money in this transaction. When Size is declining, your chances of profiting from the transaction are greatly enhanced.

No comments:

Post a Comment