Options are one of the most complicated tools in your investing box. One cannot avoid interaction with options in the investing world, which is why it imperative that you understand it by educating yourself in financial investment. Once you’ve grasped the handles of options trading, you can find vast earnings and advantages in options not found in other financial instruments.
The practice of selling options is more beneficial than buying them, but the success of either strategy depends entirely on the environment. Selling premium- the term used for selling options – provides the best prospect for success. As this is a way to minimize risk, most professional Market Makers (often known as Floor Traders) prefer to only trade stock options. When selling premium you triumph in three situations, (from a price direction perspective): when the stock price remains the same, when it moves in your favor and even when it moves against you, but only slightly.
On the contrary, you can make considerable earnings on buying premium as well, but only in one scenario: when the stock price moves in your favor, quickly.
Implied Volatility represents the stock’s expected volatility over the life of an option. One looking to make profit in options trading can be very successful if they’re on the right side of implied volatility changes. The price of your options can increase if implied volatility increases, and that happens when expectations or demand for that option increases. On the other hand, if market demand for the option decreases, implied volatility goes down resulting in cheaper option prices. That is the best time to buy premiums. Hope for an expansion in implied volatility in which you can sell owned premiums, before a contraction in implied volatility hits you.
Theta is the measurement of the time decay of an option, and is often simply referred to as time decay. It measures the rate of decline in an option’s value due to passage of time, keeping everything else constant, as the expiration date of the option draws near. Theta is a non-linear value and exponentially increases as you get closer to the expiration date. Once expired, the time value of the option becomes zero, leaving only a degree of the option’s intrinsic value. A short option has a positive theta and works in your favor as a premium seller. A long option has a negative theta which works against you as a premium buyer.
Your primary strategy is selling premium. This ensures that the overall theta of your portfolio remain high, and you can slowly collect premium on a day-to-day basis. You will gain more control over profitability, if you extract theta daily and keep your short strikes within a specified profit range. Normally, you should collect 0.1% of your total account in theta decay per day.
For example, if you’re trading a $10,000 account and can collect $10 per day. If you do so, you will see an annual return of 36%, if everything else remains constant.
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