Option writing is a trade that requires both vigilance and diligence. We will discuss today how to embed option writing to your trade when it is compulsive to write options. This discussion becomes all the more important as we enter the season of festivals. How?
Let me explain, more festivals = more trading holidays. Now just like death and taxes, the one thing that is certain is the decay of a bit of a value every day from option premium.
With more trading holidays the risk of getting brutally hurt by wild movements while writing options reduces as ever-shrinking time value takes part of the blow.
Considering, sometimes when more than one trading holidays occur especially in the second half of the week, option writing becomes a compulsive trade.
Let me take the example of three kinds of traders and understand how embedding option writing in this environment would help
Single futures Buyer/Seller
If one is trading only in futures, option writing can be added to the trade by selling higher call against bought future or selling lower put against sold future.
What this goes to do it restrict the profit up to the strike of option sold but in return futures buyer/seller gets compensated by a take-home premium.
And let’s face it everyone’s greed gets taken over by the fear of losing what’s on the table at some point in time. We just need to identify that level and sell an option of that strike.
Ideally, while trading, this may not be a good idea because if the stock were to move in the direction of choice too soon option sold may eat away more profit than expected from the premium received. But, in case we have a situation where next 10 calendar days have just 5-6 trading sessions, the premium decay would make sure that expected benefit from the option sold would be greater (in case of the adverse move) than expected loss (in case of the favourable move).
Single Option Buyer:
Most of the time option traders would like to keep it simple by buying an option and considering the premium as a maximum loss. However, be it limit of the stock to move or limit to our greed is still a finite number.
Having said that with excessive trading gaps, what would end up happening is while the time is pulling premium down, the price is not getting as many chances to push the premiums up as a result, in spite of achieving the desired price objectives in the underlying, the gain in option premium ends up being almost nothing.
The only way to counter this is by getting back from the time what time is taking from you. Just for these peculiar stretches take an additional sell option trade. By going short on the same option (Call/Put) of strike price coinciding with the price objective and let the time take its course.
Distant Strike Option Sellers:
This little piece of adjustment is for the distant option traders who just enter the option selling at the beginning of the expiry and wait till the end of expiry. An additional writing opportunity emerges for these writers.
Whenever one has more than usual trading holidays, especially in the second half of the expiry, best trade to take is to sell both call and put of the strike closest to the current price and buy protective higher call and lower put of strikes attained by adding twice the total premium received to the strike sold.
What this would essentially do is get you the creamiest option to write and more often than not a couple of trading days would pass by and the writer would end up getting the nearly same amount of premium as one would get by sitting on that far-off sold option in first couple weeks of expiry.
Thus it is compulsive to add option selling trade when you have more than one truncated weeks for trading in the second half of the expiry as the expected return (possible benefit – possible damage) would always be positive.
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