How to Make Money with Options

Selling options is another way to profit from option trading. The basic idea behind the option selling strategy is to hope that the options you sold expire worthless so that you can pocket the premiums as profits. Selling Options is an excellent strategy to make money with options.

The option premium represents the entire income the option seller can hope to achieve, while his losses are theoretically unlimited. The option buyer on the other hand can only lose the option premium while his return is theoretically unlimited.

Implied Volatility

When selling options, one should take note of the implied volatility (IV) of the underlying asset. Generally, when the IV is high, the option premium goes up. When implied volatility is low, option premium goes down. So you would want to sell options when IV is high, and buy them back when it is low.

Make money with options

So why would anyone sell options? Why doesn’t everyone just buy options if they have limited loss and unlimited profit potential. The main reason is probability!

Investors who understand options know that over time that the loses they have to pay to option buyers will be less than the income they earn from the premiums the buyers pay. Studies suggest that between 75% and 80% of options held to expiration expire worthless. This means that option sellers win 75% to 80% of the time!

In addition to probability there are other reasons in that make selling options incredibly attractive as a wealth creation strategy. They include:

* Excellent returns
* Inbuilt safety factor
* Consistent income
* Win in all market conditions
* Less risk
* Time is on your side

Let’s quickly look at each of these in turn…

 

Excellent returns:

Selling options can provide an excellent good Return of Capital.  You can make amazing returns…returns like 30% to 50% per trade.

 

Inbuilt safety factor:

One of the biggest problems with using stocks, futures, and other financial products that you need to have excellent timing and deep pockets to use them effectively. While I love the adrenalin that these products give me they do not have the type of safety factors that help me to sleep well at night.

How many times have you bought a stock, futures contract etc on the expectation that its price will rise and sure as night follows day the price immediately starts to fall. Soon you find yourself stopped out only to see its price turn around again and rally just as you originally predicted. Essentially these products give you only a small margin of error.

We all know that markets do not move from point A to point B in a straight line…they zig zag their way there…sometimes with quite violent corrections. The more volatile the market the more difficult using linear products becomes, because your likelihood of being stopped out increases. Options give you that margin of error that means you don’t need to worry about timing to anywhere near the same degree.

Option sellers have a much higher degree of staying power. They can withstand the zig zagging of the markets much better. For example, if a market is in an up trend you can sell an out-of-the-money put at a level that gives you a very large level of comfort that the price will never fall to a level where your option will be exercised. Timing the market is much less important.

Consistent income:

Those that sell options can enjoy a regular income month after month. It will not provide you with a 1,000 percent return in a year, but with education, practice and good option selection you can enjoy 30 percent to 50 percent annual returns. But there is a lot to be said for receiving excellent, regular and fairly stress free income. Everyday your options are getting closer to expiry and time decay is eating away at their value. Every month you can receive income from your options expiring.

 

Win in all market conditions:

It is said that markets go up, down and sideways. In actual fact they go up a little, up a lot, down a little, down a lot and sideways. With linear products you can only win with one third of the movements. For example, if you are bullish, then you will loose if markets go down or sideways (or at least not gain anything). However, if you sell a deep out-of-the-money put option to take advantage of your bullish view then you will win with four out five market movements. In other words you will win if the market goes down a little (it will not hit your put’s strike price), stays flat, goes up a little or goes up a lot. You will only loose if the market falls sharply.

 

Less risk:

When most uneducated investors think about options their first reaction tends to be “that sounds risky”. In actual fact options are a lot less risky than trading stocks, futures, CFDs etc. The key reasons why options are less risky are:

* You can sell out-of-the-money options that are very unlikely to be exercised.

* Most expire worthless – we know 75% to 80% of options expire worthless. With the strategy of Managing Winners you make sure that you lock in profits.
* Out of the Money Option prices do not move one for one with the underlying price. In other words if the price of the underlying goes up one point your out-of-the-money option price will only change by a fraction of this.

* There is much more money involved trading 100 stocks than trading 1 option contract (which represents 100 stocks)

 

Time is on your side:

Those that buy options need the price to move beyond the option strike price (plus the option premium) before expiry if they are to make money. From the moment they buy an option time is working against them…it is a race that the price can move enough before their time runs out. This process is called option decay.

For the option seller it is exactly the opposite. From the moment they sell their option they have been paid and the option’s time is working for them. Every day the option’s worth becomes a little less to the option buyer and a little more to the option seller. The option seller does not have the pressure that time will run out…the option buyer always wants more time, while the option seller happily watches time run out.

I hope you’ll agree that option selling is a powerful method of generating low pressured, consistent and extraordinary returns.

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