|
The 2019 stock market starts with high volatility in the first week
of trading. The market was down and up triple digits on 2 consecutive
trading days on January 3rd and 4th. Market volatility creates difficulty
for stock traders to time entry and exit points. However, option traders
love this market volatility for the juicy premium.
We all know stock traders trade with true value whereas option
traders have the addition of volatility and time value. When the price is
high, it is tough to buy stock or option. If that is the case, why not
jump to the other side and be an option seller instead? Option sellers
will take advantage of market volatility to sell option and let
volatility and time value dictate the profit. I
have heard option buyers complain about buying put before earning
anticipating bad result. Assuming they are right and the stock drops
after bad earning report. However, they then realize their put option
doesn't make big money as expected or in some cases, it loses money. What
the option buyers don't realize is the market volatility. Before earning
report, uncertainty is high and so is the volatility. They buy option
with true, time and volatility value. For a very volatile stock, option
value is made up of mostly volatility value. After earning report is
announced, uncertainty and volatility are gone and so is the option
premium. Option sellers, in this scenario, can still make money even if
the stock doesn't drop big. The reason is volatility. When volatility
collapses, so is the option price. Option sellers can buy back the put
with less money or simply let it expire worthless and realize profit.
The above example is a simplified case to illustrate the power of
volatility. In reality, option sellers apply more than one strategy to
trade volatility. Besides selling naked put as illustrated above, they
also sell vertical puts to release capital requirement for the trade or
they sell short strangle with a range they feel comfortable with. The
beauty of these strategies is after establishing the trades, the sellers
can sit back, relax and let volatility and time do
the work for them. In a smooth case, option sellers often don't need to
do a lot of work. They simply wait until the 3rd Friday of the month,
letting their options expire worthless and happily collect profit. Of
course, we are not living in a perfect world so adjustments are usually
needed.
Two things I learn from my option selling experience is buying back
short option positions with $0.05 value or less and taking profit when
our gut feeling tells us to do so. When a short option
position goes well and has $0.05 value with, let's say, 2
weeks left, it means the most we can make for that particular position is
$0.05 in the next 2 weeks. Why take unnecessary risk for only
$0.05/share? After we buy back our $0.05 position, we release our capital
requirement and then use it to create a new position in the following
option month. More than 90% of the time, our new position will make more
than $0.05/share. Make sense? Another reason is a moral one. When
we see we make about 80% of the anticipated profit and our gut feeling
tells us to get out, just do it. Think about leaving the other 20% on the
table for the others to take it. Money is everywhere on the street. Learn
how to benefit from it and our life will be a lot healthier and happier.
Cheers,
|
