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 connecting the world’s capital markets.
However, selling options is a unique undertaking that requires a comprehensive understanding of the process. While this may be suitable for some, it is certainly not a pursuit that is suitable for everyone. Read on to find out whether engaging in the sell side of the options markets is a viable way to achieve your monetary goals.
When is it a good idea to sell options?
Before deciding whether or not selling options is for you, it is important to first understand what is involved in the undertaking. When you sell, or “write,” an option contract, you are legally obligated to fulfill the terms of a call or put. Although it can be a profitable strategy, writing options is a serious business that requires you to assume theoretically unlimited risk.
For example, if you sell (or write) a call option of Chicago Mercantile Exchange (CME) 2021 December Gold (GC) With a strike of $1700.00, you are guaranteed a transaction. This means that the buyer has the right, but not the obligation, to purchase 1 December gold at $17000.00 at the expiration of the contract. When writing (or selling) a call, here’s what happens:
- You become legally bound by the terms of the contract.
- You are credited with the premium of the option immediately.
- If GC fails to reverse above $1700.00 by expiration, you profit from collecting premiums. If the GC rises above $1700.00 at expiration, you will have to pay the difference between the current market price and the strike. This may exceed your revenue from premiums.
The uncapped exposure of selling options scares many traders away from the strategy, and rightly so. Crushing losses can be felt from uncertain markets, as we saw during the COVID-19 panic of March 2020. Despite the risk, there are times when it is a good idea to sell options.
steady cash flow
Everyone needs money at some point or the other. Selling options is one way to generate steady cash flow in exchange for assumed risk. Let’s say you decide to sell that CME December Gold call for $1700.00. The contract is trading at the money (ATM) and commands a $15.00 premium. Given the contract size of 100 troy ounces, $1500.00 ($15.00 x 100 ounces) is credited to your account. Upon termination of the contract or liquidation of the position, part or all of the $1500.00 may become the actual profit. Although the eventual profitability of the trade will depend on price action, selling the option is one way to meet a periodic need for cash.
The practice of option writing is included in many professional trading strategies. Here are three of the most popular:
- bull call spread: Under a bull call spread, the trader simultaneously buys and sells calls in the same contract (with the same congruent underlying assets and expiry date). Calls written have a higher strike price than calls that are bought, providing bullish market exposure with a lower up-front premium cost.
- bare put spread: A bear put spread involves the simultaneous buying and selling of a put option on the same contract. Written puts are priced lower than bought calls, thereby protecting bearish market risk at a lower up-front premium cost.
- protective collar: The protective collar strategy is executed by buying 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 who already hold profitable positions in the underlying asset of the option.
In practice, there are a large number of strategies that integrate selling options into one comprehensive business plan. Due to the complexity of option pricing and the intricacies of market behavior, many traders rely on the expertise of their broker for guidance.
Take advantage of the potential of options with Daniels Trading
When you are 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!
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