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Introduction to Option Selling

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Carley Garner, coauthor of Commodity Options: Trading and Hedging Volatility in the World's Most Lucrative Market, explains why she believes that option selling is one of the most attractive forms of trading.

Options offer traders an unlimited number of strategies with various levels of risk and reward. Unfortunately, many retail traders are stuck in a long-option-only "rut" and may not be aware of the potential flexibility offered by alternative option strategies. There is certainly a time and a place for buying outright options, but in my opinion most circumstances seem to favor an alternate approach. I believe option selling to be one of the most attractive forms of trading, but proper risk-management techniques are a must, as the risks are high.

Short Option Trading

I have witnessed beginning traders lured to the markets in droves, looking to participate in long-option strategies. Their attraction stems from the fact that option buyers are faced with the prospects of unlimited profit potential and limited risk, in the amount of premium paid plus commissions and fees.

The hazard in this type of mindset is that although one's losses are limited, it's highly likely that an option buyer will lose some or all of the value of the option. Several studies suggest that more options than not expire worthless; accordingly, it seems logical that simply selling options as opposed to buying them is a preferential strategy.

Contrary to what many might believe to be the case, it's possible to buy a call option and lose money even if the market goes up. This is due to time-value erosion and decreases in volatility or demand for the instrument. On the other hand, the seller of that same call could be profitable despite the fact that the futures price increased, assuming that time-value and/or volatility has eroded.

Unlike buying a call, selling a call option is a bearish strategy. Call-option sellers believe that the market will decline in the opposite direction of the strike price, or at least manage to stay below it.

I've found that it may be preferential for option sellers to initiate positions on a day in which the market is going against the soon-to-be position. In essence, call options should ideally be sold during times of elevated market prices, and thus elevated call premium. This could mean that the market is approaching the top of a trading range, or simply overbought. Selling against the trend may seem like account suicide, but it can often be justified by inflated premiums.

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