Beneficial Strategy of Selling Options on Futures and Commodities

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Selling options can be an excellent trading strategy to help put the odds in your favor - if done properly. If you don’t manage your risk when selling options, things can go bad in a hurry.

Benefits of Option Selling

The most important benefit: Time is on your side.

Options have a limited life and every day that ticks by means that options are losing time value. Option buyers certainly know that dilemma.

It is a bad feeling to know that you picked the right market direction, but you still had a losing trade due to the evaporation of time value on your options.

Time decay on options allows you to make money on a trade even if the underlying market stays the same when you sell options. You can also make money on a trade if the futures market still moves against you, because the option might not move enough to make up for the loss in time value.

Odds in Your Favor

It is no secret that a majority of options expire worthless. This is a simple fact, yet it can help put the odds of trading in your favor and make your commodity trading a profitable experience. You can almost throw darts at a list of out of the money futures options to pick your trades. Likely, most of them will expire worthless, which means it is 100 percent profit before commissions and fees when you sell options that expire worthless.

Unlimited Risk With Selling Options

Every trading strategy in commodities, futures and options does have its downside. An option selling strategy entails virtually unlimited risk. Therefore, if you sell a naked option (not covered or hedged) you run the risk of taking huge losses. Option sellers often win on a high percentage of their trades, yet they have a couple losers that are greater than all their wins.

That is why it is so important to control your risk when you a selling options.

There is a similar principle with a trend following trading system. Under a system like this, most of the profits for the year are made on one or two trades where the commodities make major moves. Most of the other trades are losses. Traders who use a system like this rely on a couple of trades to make their profits for the year. When you sell options, you want to make sure those couple of trades don’t turn into your big losses for the year. You can generally do well in the commodities and futures markets by selling options if you are able to manage your risk and sell out of the money options and not let a few bad trades destroy your account.

Profit Potential vs. Risk

Option buyers have the luxury of unlimited profit potential. Option sellers can only make 100 percent profit, or the amount of premium they receive minus commissions and fees. Many commodity traders like the benefit of unlimited profits. From my experience, most traders don’t have many trades where they make more than 100 percent anyway. They are too quick to take profits. So, if you don’t make 100 percent plus returns on trades and you have a lower percentage of winners when you buy options, why wouldn’t you want to sell options instead of buy options.

Selling options is simply a matter of putting time and the odds in your favor. This is what I call giving yourself an edge in the markets. It is up to you to control the risk by not risking too much of your account on any one trade and you must cut your losses if the trades move too far against you. Just assume you that two out of every three options that you sell expire worthless. On the losing trades, you keep your risk to 100 percent of the option premium. In the end, you will still come be profitable if your every two out of three options expire worthless – which is about the industry average.