The 2019 stock market starts with high volatility in the first week of trading. The market was down and up triple digits on 2 consecutive trading days on January 3rd and 4th. Market volatility creates difficulty for stock traders to time entry and exit points. However, option traders love this market volatility for the juicy premium.


We all know stock traders trade with true value whereas option traders have the addition of volatility and time value. When the price is high, it is tough to buy stock or option. If that is the case, why not jump to the other side and be an option seller instead? Option sellers will take advantage of market volatility to sell option and let volatility and time value dictate the profit. I have heard option buyers complain about buying put before earning anticipating bad result. Assuming they are right and the stock drops after bad earning report. However, they then realize their put option doesn't make big money as expected or in some cases, it loses money. What the option buyers don't realize is the market volatility. Before earning report, uncertainty is high and so is the volatility. They buy option with true, time and volatility value. For a very volatile stock, option value is made up of mostly volatility value. After earning report is announced, uncertainty and volatility are gone and so is the option premium. Option sellers, in this scenario, can still make money even if the stock doesn't drop big. The reason is volatility. When volatility collapses, so is the option price. Option sellers can buy back the put with less money or simply let it expire worthless and realize profit.


The above example is a simplified case to illustrate the power of volatility. In reality, option sellers apply more than one strategy to trade volatility. Besides selling naked put as illustrated above, they also sell vertical puts to release capital requirement for the trade or they sell short strangle with a range they feel comfortable with. The beauty of these strategies is after establishing the trades, the sellers can sit back, relax and let volatility and time do the work for them. In a smooth case, option sellers often don't need to do a lot of work. They simply wait until the 3rd Friday of the month, letting their options expire worthless and happily collect profit. Of course, we are not living in a perfect world so adjustments are usually needed.


Two things I learn from my option selling experience is buying back short option positions with $0.05 value or less and taking profit when our gut feeling tells us to do so. When a short option  position goes well and has $0.05 value with, let's say, 2 weeks left, it means the most we can make for that particular position is $0.05 in the next 2 weeks. Why take unnecessary risk for only $0.05/share? After we buy back our $0.05 position, we release our capital requirement and then use it to create a new position in the following option month. More than 90% of the time, our new position will make more than $0.05/share. Make sense?  Another reason is a moral one. When we see we make about 80% of the anticipated profit and our gut feeling tells us to get out, just do it. Think about leaving the other 20% on the table for the others to take it. Money is everywhere on the street. Learn how to benefit from it and our life will be a lot healthier and happier.







Dennis Phan   潘家墉

Khai Minh, UCLA and Investools Alumni.

10 Jan 2019 in Claremont, California, USA












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