Options Contracts are traded for many reasons. Some Options Traders use them to mitigate risk. Others use them to speculate on price direction or the movement of Implied Volatility of the underlying instrument. Another group trades them to generate income. This is the group that collectively tends to have the greatest amount of risk. If you are Selling Options to generate income you should be fully aware of the risks associated with this type of Trading. As a former Options Trader in the Options Pits in New York and later as Head of Risk Management at ICE Futures, Inc. I’ve seen my share of blood baths and only once was it associated with a trader who was Long Volatility. No matter what contract you are trading, the concerns are the same.
For those that are using Options to mitigate risk, consider the following factors: 1) are you sure you are getting the best value when trading and 2) are you determining the level of Liquidity in the market before you execute your hedge. Getting the best value frequently involves choosing the appropriate Options Trading Strategy to meet your needs. At Options Strategy Network we work with clients to help them find the best Strategy to meet their risk/reward requirements. When mitigating risk in equities that is relatively easy to do. By analyzing the Implied Volatility Skew it is often possible to find the appropriate Options Trading Strategy. In addition to finding the appropriate Options Trading Strategy, you must be sure that the cost of executing the transaction is not too high. By examining Liquidity, or the difference between the Bid and Ask Prices, and dividing it by the Ask Price, you can establish the liquidity percentage. Only examine at-the- money or out-of-the money Options when making the Liquidity Analysis. If you compare the Liquidity of your Options Contract to that of a slightly out-of-the money the E-mini S&P Option, you’ll be able to see how the Liquidity of your product fits in. The E-minis set an excellent standard.
For those that are Buying Options to speculate on Price Direction or Implied Volatility, the main things to look for are the same. In order to be successful, you must consider Historical and Implied Volatility, the Implied Volatility Skew and Liquidity in all of your decisions. If you fail to consider those factors you will most certainly be less profitable in the long-run. 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 will increase your understanding of all facets of Options Trading. Take a look at our Full Syllabus and the rest of our Website to see where your knowledge base fits in.
For those who Sell Options for Income, you probably know just how quickly markets can turn. A Negative Gamma Position can change your Net Delta, either Long or Short, much more quickly than you planned on. I won’t attempt to discourage you from Selling Option Premium, but will encourage you to only trade in Liquid Markets. Giving up a large edge to get in and out of positions, while adding in commission costs, makes Trading Illiquid Markets deadly for those that are Premium Sellers. If you are following Historical and Implied Volatility, Liquidity and choosing your spots carefully, there is certainly money to be made. If you are Trading Covered Call Strategies, be sure you understand that you are Selling Synthetic Puts and may only make sense if the Price of the Call is Trading at a Premium. On our Website there are two PowerPoint Presentations which may be helpful in improving your profitability. Take a look and Contact Us with any questions.
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.