Selling Options

Keenes #1 Trading Rule: Never Ever Sell Options Naked! Risks & Advantages The seller or (writer) of a Call options contract is obligated to deliver the underlying the underlying asset at the agreed upon price. Short Naked Calls has UNLIMITED risk of loss The seller (writer) of a Put option contract is obligated to receive (buy) the underlying asset at the agreed upon price. Short naked Puts have limited risk of loss but still have ability to BLOWOUT your trading Account. Keenes #1 Trading Rule: Never Ever Sell Options Naked! Key Advantage – Using Theta (time decay) to your advantage

Short Call Outlook: Stock will decrease or stay flat by expiration Trade: Sell Call Option Advantages: This position can be profitable if the stock falls or stays flat Disadvantages: Unlimited loss Potential! Increase in implied volatility Will hurt this position Max Risk : Unlimited Max Reward : Credit received for selling the call option Breakeven: Strike Price plus credit received for selling the call Delta: Negative: The higher ITM the higher the delta, always between 0-100 Gamma: Negative: Always highest ATM and closest to expiration Theta: Positive: Always highest ATM and closest to expiration Vega: Negative: Always highest ATM and furthest from expiration Rho: Negative: Higher interest rates will decrease call value Synthetic: Short Put + Short Stock So far our examples have been towards having a Long Option position in which Time Decay (theta) is eroding the value of the option. In Contrast, when you write options, (short position) this time decay is a benefit. As a short seller of options you want the option to expire as fast as possible, thus retaining all the value you initially sold to the buyer. Short Call: Selling Calls naked (without a hedge) although a bearish strategy, is one of the worst risk rewards trades there is. As the graph displays the profit portion extends down and to the left. This indicates that your risk of loss is technically unlimited offering only limited reward. This is a very advanced strategy that in my opinion is used in shorter time frames as a trade to collect option premium in expectation that the option sold will expire worthless, allowing the trader to keep the credit received.

Graphs of a Short Call Option Where is ITM? Where is ATM? Where is OTM?

How to manage a Short Call on Expiration Scenario 1: Stock Falls Below Strike Price on Expiration: Calls will expire worthless. Scenario 2: Stock Rises Above Strike Price on Expiration The calls will convert to a short stock position. If I do not want to take delivery of the short stock can either buy stock or buy short calls back to hedge position and be flat after expiration. Keenes Trading Tip: Remember that Theta effect is most pronounced with 30 days or less till expiration. To take full advantage of this effect I often implement short option (spreads only) with less than 30 days left till expiration. Picture _ Management Show Example

Chart Example Picture _ Stock chart of Stock moving up. Lets

Chart Example Picture _ Stock chart of Stock moving up. No matter how much the Stock goes down your calls that you sold will only yield a maximum profit of $5.00

Chart Example Picture _ Stock chart of Stock moving up. No matter how much the Stock goes down your calls that you sold will only yield a maximum profit of $5.00

Short Put Outlook: Bullish or Neutral Trade: Sell Put Option Advantages : This Trade can be profitable if the stock stays flat or rises before expiration. This can be a considered cheaper way to establish a long stock position. Disadvantages: You expose your trading capital to substantial risk if the stock falls Max Risk: Put Strike – Credit received for the sold put option Max Reward: Credit received for the sold put option Breakeven: Put Strike – Credit received for the sold put option Delta: Positive: The higher ITM the higher the delta, always between 0-100 Gamma: Negative: Always highest ATM and closest to expiration Theta: Positive: Always highest ATM and closest to expiration Vega: Negative: Always highest ATM and furthest from expiration Rho: Positive: Higher interest rates will increase Put value Synthetic: Short Call + Short Stock Short Put : Selling Puts naked, although a bullish strategy is also very risky, albeit less than selling calls naked. You can see this is true because the risk graph extends down and to the left, indicating as the stock falls you are accumulating losses, but since stocks can only go to zero your losses are capped at a certain point. You are essentially speculating that the stock will stay above the strice price that you sold till expiration, where you will keep the full credit received for sale of the put. If the stock price ends up below the strike price you sold, at expiration, chances are you will be assigned the stock.

Graphs of a Short Put Option Where is ITM? Where is ATM? Where is OTM?

How to manage a Short Put Scenario 1: Stock Rises Below Strike Price on Expiration: Puts will expire worthless. Scenario 2: Stock Falls Below Strike Price on Expiration The Puts will convert to a long stock position. If I do not want to take delivery of the long stock can either sell stock or buy short puts back to hedge position and be flat after expiration. Keenes Trading Tip: I Typically never short Options Naked. If I do sell puts it is usually when the stock is trading at a really low level (ie under $3.00 and in a stock that I don't mind being assigned at expiration.

Picture _ Stock chart of Stock moving up. Remember : Long options value erodes over time, A one month option comparted to a 12 month option as far more theta efffect. So in essence you will be paying far less “per day” to own a call that is 12 or 6 months out than a 1 month option.

Picture _ Stock chart of Stock moving up. Remember : Long options value erodes over time, A one month option comparted to a 12 month option as far more theta efffect. So in essence you will be paying far less “per day” to own a call that is 12 or 6 months out than a 1 month option.

Picture _ Stock chart of Stock moving up. Remember : Long options value erodes over time, A one month option comparted to a 12 month option as far more theta efffect. So in essence you will be paying far less “per day” to own a call that is 12 or 6 months out than a 1 month option.

Picture _ Stock chart of Stock moving up. Selling Options Review Outright Short Options have poor risk / reward profiles Time Decay Effect works for a option seller Volatility is the enemy of a option seller Short Calls have Unlimited Risk Cash Secured Short Puts can be a way to get long stock (elite trader strategy) Stocks can only go down to Zero KOTM #1 Rule : Never Sell Options Naked Picture _ Stock chart of Stock moving up. Remember : Long options value erodes over time, A one month option comparted to a 12 month option as far more theta efffect. So in essence you will be paying far less “per day” to own a call that is 12 or 6 months out than a 1 month option.

Protective Put A long put added to a long stock position. This strategy insures the stocks value, limiting the downside risk of the long stock Position As can be seen in the P&L graph of this strategy It has the exact same risk profile as a long call. Protective puts are especially attractive in environments of low volatility. The premium for this insurance is relatively “cheap”

Selling a Cash Secured Put You are willing to acquire the stock at a lower price. Cover the cost of the stock if it is assigned by buying T-Bills. If stock is not assigned you collect the premium from the sale of the put

Cash Secured Put Example This strategy can be attractive in a inflated volatility environment as there is more premium to sell in these options. Example: Cheniere Energy (LNG) is trading at $42.50 We can sell the LNG Oct 42.5 Puts for $2.50 with cash in our account to purchase shares of the stock if it declines. Here we are able to lower our cost basis to $40.00 dollars, meaning if the stock declines we are long the shares at $42.50 or get to keep the $2.50 in premium we sold the Puts for if the stock does not get put to us.

Covered put write A bearish strategy that involves writing put options while shorting shares of the underlying. Maximum profit is limited to the premium received from the sale of the put plus the profit from the short stock up to the strike. This happens very rarely. There are better ways to get short a stock.

Other Put Strategies In general protective puts are the most common strategies employed by the retail investor. In some cases, if there is an inflated volatility environment, protective puts become relatively expensive and other hedging strategies might be more attractive. Cash secured puts can get a trader into a stock at a discount, but keep in mind the stock must sell off before it gets put to you. This has you in a position of buying stocks that has been heading lower. Also, in your trading account, these Puts will mark-to-market, so if you are short them and they increase in value, then your trading account loses money.