Traders Edge

Options Education

Selling Strategies

There are four primary strategies we implement involving the writing (selling) of options. All examples are excluding commissions and fees.

1. Uncovered Writing*

Uncovered, or naked writing, involves selling a call OR put without entering into an underlying futures contract. A naked call writer has a neutral to bearish view of a market, while a naked put writer has a neutral to bullish view on a market. In most cases we recommend selling out-of-the- money options. This means selling a call with a strike price that is above the futures price or selling a put with a strike price below the futures price. In either case a dollar amount, or premium, is collected and credited to a client’s account. In the case of a short call this premium is retained if, by expiration, the futures has moved lower, stayed the same, or moved higher but not up to the strike price of the call. In the case of a short put the premium is retained if the futures has moved higher, stayed the same, or moved lower, but not down to the strike price of the put. Being short a naked option has unlimited risk.

Example: If silver is currently $24 an ounce, you can sell seven months till expiration $50 call option for $700. On expiration you will keep the $700 if the market remains below $50 even if the market doubles in value to $48 at expiration, the $50 call is worthless. However, For every dollar below $24 the option value increases by $5000.

1. The Short Strangle*

A short strangle is a strategy in which a trader simultaneously sells both an out-of-the-money put AND out-of-the-money call in the same market for the same contract month. This is the optimum strategy for trading sideways markets. All of the premium which was collected upon the initiation of a strangle will be kept if the underlying futures contract is between the strike prices on expiration. This type of trading can also have unlimited risk.

Example: If silver is currently $24 an ounce, sell a seven-month $50 call and a seven- month $16 call for $1300. Both options are out-of-the-money. You will keep the entire premium if at expiration silver is above $16 and below $50. For every dollar above or below the strikes the value increases by $5000.

1. The Credit Spread*

A credit spread is a strategy that involves simultaneously selling an option and buying an option in the same month farther away from the market. The strategy is called a credit spread because the option that is sold has a greater value than the option that is purchased.

Example: Gold is currently trading at $1900. An example of a credit spread would be to SELL a 90 day $1800 put and BUY a 90 day $1750 put. For the $1800 put you collect $2,200. For the $1750 put you pay $1,250. By selling this credit spread you collect $950. If on expiration gold is above $1800 the maximum profit of $950 is retained. The maximum risk on this credit spread is $4,150. This loss would be realized if the market is at or below $1750 on expiration. The same type of trade can be executed on the call side.

1. Ratio Write*

Buy one closer to the money call (or put) and sell more than one deeper out of the money call (or put).

Example: Buy one seven-month $35 call for $2300, sell 4 seven month $45 calls for $3600. A credit of $1300 is obtained. On expiration, if silver is at or below $45 the trader will have a profit between $1300 and $51,300. The maximum risk is unlimited.

*Excluding commissions and fees.

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