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By
James Cordier, Liberty Trading Group
There are as many different option strategies today as there are traders.
Vertical spreads, covered calls, ratio spreads, double ratio backspreads,
the infamous butterfly spread. Complex computer programs analyze mountains
of data for traders to select the precise option or combination of options
for traders to sell. Unfortunately, these computers still can't tell you
which way the market is going to go.
There is an approach to the market is amazingly simple. If a market is
identified as having only the very clearest of long term fundamentals, be
it bullish or bearish, options can be sold in the opposite direction. When
selling an option, an investor statistically has an approximate 80% chance
of the option expiring worthless. This is before he even selects a market
or strike price to sell. Thus, if bearish a market, a trader would sell
calls. If bullish, he would sell puts. He sells strike prices either far
above or far below the current price of the futures market. He places a
stop (I recommend 200% of the current value of the option). And then he
sits back and watches.
While multiple option combinations all have their merit in the right
situation, a pure option selling program can be successful based on it's
sheer simplicity. The benefit of always having time value working in your
favor (eroding the option on a daily basis) can be a tremendous advantage.
The huge margin for error, whether it be mistiming an entry or being
outright wrong the market, can allow an investor to profit in a short
option trade where a long option or futures trade would have resulted in a
loss.
Patience - The Underrated Virtue
In John Walsh's book, How to Trade Futures, he interviews several
professional traders on the subject of trading. One particular quote struck
me as extremely relevant. It is from a professional trader who has been
successful over the years:
Patience
is a common attribute of many experienced, successful traders. Beginners
are almost never patient. They want to "do something." Often
they are proactive in their business and personal lives and want to trade
the same way. In futures, riches often come to those who have the
discipline to wait…"
No where is patience more important than in an option writing investment
portfolio. Lack of patience can result in the option seller overtrading his
option portfolio, over exposing himself by putting on too many positions,
over weighting his portfolio in one position, or "reaching" for a
new position instead of waiting for an opportunity to arise.
While many novice traders shun option selling for fear and misunderstanding
of the risks, in reality, option selling can be a consistent, relatively
conservative approach to the market. Percentages and time will be on your
side, but if you trade for action and excitement, option selling may not be
for you.
Traders adopting a longer term strategy such as this can avoid all the
daily decision making such as resetting stops, taking profits, trying to
outguess the market (and the pros) can watch the market from more of an
objective distance.
Most investment managers recommend that you work with an experienced
professional if you wish to try your hand at option writing. I tend to
agree with this view. While if utilized correctly, option writing can be an
extremely effective tool for strong portfolio returns, one must not get
lured into a "can't lose" mentality. This is still futures
trading and there are still risks involved. Right when you start to believe
you can't lose, you will.
Look to sell far out of the money options in markets with clear long term
fundamentals and be aware of seasonal tendencies. Don't second guess
yourself or the trade. If your risk parameter is hit, exit the position. If
it is not, leave it alone. Remember that, unless the market is moving
sharply against your position, time value will eventually make you a
winner.
Keep it simple. Cultivate your patience.
About The Author
James Cordier is head trader and president of Liberty Trading Group, a
brokerage firm specializing in option writing on commodities. James' market
comments are published by several national financial publications and
worldwide news services. For more research visit Liberty
Trading Group
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