Options writing has become a taboo after many mishaps in the last few years seen by some of our fellow unfortunate traders. But out of that getting scared and leaving the idea of selling options is not advisable.
So, we will discuss today different ways to benefit from Option Writing which takes care of the unattractive unlimited loss feature of short options. The way to do this is by going through the Embedded Short Option Route.
There are situations where market slows down. Here, there comes along a lot of time that has to be killed before the move materializes. On the other hand, there could be a season of trading holidays, where there is an inevitable time to be killed.
Such situations compel us for the Short option strategy which capitalizes on the passage of time with limited or no action in the underlying. Even in these situations though, we do have the risk of a very big loss in case things turn against us. However, Embedded positions do not have such risk. Let us see how we can embed options first with Futures trades and then with Options trades.
If one is trading only in futures, options writing can be added to the trade by Selling Higher Call against Bought future or Selling Lower Put against sold future. What this does is, it restricts the profit up to the strike of option sold but in return Future Buyer/Seller gets compensated by a take home premium.
And let’s face it everyone’s greed gets taken over by the fear of losing what’s on the table at some point. We just need to identify that level and sell an option of that strike. Ideally, while regular trading this may not be a good idea because if the stock were to move in the direction of choice too soon Option sold may eat away more profit than expected the benefit from the premium received.
But, in case we have a situation where next 10 calendar days have just 5-6 trading sessions or the momentum is completely killed, the premium decay would make sure that expected benefit from the option sold would be greater (in case of adverse move) than expected loss (in case of favorable move).
Often times Option traders would like to keep it simple by Buying an Option and considering the premium as maximum loss. However, be it limit of the stock to move or limit to our greed is still a finite number.
Having said that with excessive trading holidays or lack of momentum, what would end up happening is while the time is pulling premium down, the price is not getting as many chances to push the premiums up as a result, despite of achieving the desired price objectives in the underlying, the gain in option premium ends up being discouraging.
The only way to counter this is by getting back from the time what time is taking from you. Just for these peculiar stretches take an additional sell option trade. By going short on the same option (Call/Put) of strike Price coinciding with the price objective and let the time take its course.
As they say, there is a time and place for everything. Embedded Options route may not be the best way to go at all times but it definitely would help in case of slower momentum or in a typical weekend trade.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.