Selling Options For Income: How to Improve Your Chances of Making Money

While Selling Options can be a lucrative proposition, when executed under the wrong circumstances selling them naked can be a financial nightmare. If one is going to make a habit of trying to generate income through the persistent sale of Options Contracts, they should be sure to consider the following criteria on all transactions before entering the position.

The first essential quality one must find in their prospective position is adequate liquidity in their chosen contract. Liquidity provides the ability to enter and exit the trade without giving up too much of an edge. Contracts like SPY (SPDR S&P 500 Trust) typically provide the environment for establishing positions without suffering the consequences of an illiquid market. Evaluating the difference between the bid and the ask spread as a percentage provides an excellent way of measuring liquidity. (It only counts for out-of-the money options.) If one is selling inexpensive options, the percentage between the bid and ask prices is going to be high and therefore the long-term likelihood of profitability is reduced. Commission costs must also be considered.

If one has found options series that is liquid, then evaluating the Implied and Historical Volatility becomes the next essential portion of the analysis. Although Options Traders can locate trades by either first examining Implied and Historical Volatility or liquidity, if the liquidity factor is not reasonable then making the trade is suspect. Under normal circumstances, where news, earnings, and other extraneous factors are not expected, searching for Implied Volatilities significantly greater than Historical Volatility is a way to start thinking about options which might be sold.

Once one has located an instrument with an Implied Volatility significantly greater than the Historical Volatility, then an analysis of the Implied Volatility Skew becomes essential. Each market has its own Skew. Stocks and Stock Indices typically have a Skew which provides a higher implied volatility on options farther and farther out-of-the money on the put side. Gold, on the other hand, typically has a Skew towards the Calls. These Skews, when analyzed in combination with the Implied Volatility Analysis enable the Short Options Trader to locate positions that make sense given one’s market bias. At Options Strategy Network we provide lessons in trading and risk management to assist traders in fine tuning their options trading technique:  Contact us  to enhance your understanding of these issues. Our Private Webinar Training Sessions, for a fee of $75/hour, will enhance your options trading.   

For those that are interested in generating income through selling options, the analysis discussed above is essential. Remember to always:

                Analyze Liquidity
                Locate Instruments with Implied Volatilities at Levels above Historical Volatility
                Analyze the Skew to determine where the best value may lie
                Use this Analysis in conjunction with your market bias
                Choose an Options Trading Strategy which meets your risk reward profile

By analyzing Options Trading in this methodical way, one can significantly improve their likelihood of success. Establishing positions with a pre-determined point of entry and exit provide the discipline needed to manage one’s short options position. If you are trading options and don’t understand these concepts, Contact us for an Options Trading Webinar to improve your Trading Technique.

OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.

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