| Selling Premium with known risk |
Instead of buying an option vertical spread (my option letter #1), you can sell it. When you do this strategy, you know what your risk and reward is. You do not have to worry about losing an amount of money that is more than your limit of risk.
If you have a market that you feel will move in a trading range, and want to make money on that thought, think about selling two vertical spreads (one vertical call and one vertical put spread). The call spread at the resistance (the highest price you think the market can go to) and the put spread at the support (the lowest you think it can go). If the market is between those prices on option expiration, then you will keep all money collected and the options expire worthless. One fact is that either the call or put spread must expire worthless. Since this is a fact, you can add what premium you collect from the two, and apply it to the spread that might become in the money at expiration.
Example in real time:
The March07 Yen futures contract on 1/5/07 settled at 8511. The March07 Yen options expire on 3/9/07. 1 tick in the futures or options is worth $12.50.
Using 1/5//07 settlement prices in my example below:
If my thought was that the March07 Yen would trade between 8500 and 8650, instead of buying a futures contract at 8511, looking to take a profit at 8650 and a stop at 8372 (an even money risk/reward)
I would do something like this:
I would sell the March07 8500 put at 92 and buy the March07 8350 put at 36 for protection and also at the same time I would sell the March07 8650 call at 50 and buy the March07 8950 call at 12. The net collected is 92-36 equals 56 and 50-12 equals 38. 56 plus 38 equals 94. The market would need to be 94 ticks above 8650 or 94 ticks below 8500 for you to lose money. Any price between 8500 and 8650 on expiration would mean you would keep the 94 ticks. You could only lose 56 ticks if the market was below 8350 or lose 206 if the market was above 8950. Make 94 or lose up to 56 to the downside, make 94 or lose up to 204 to the upside. Meaning if the futures expire at 8680, an 8650 call is worth 30 ticks and if you collected 94 ticks from the spreads, you would have still made 64 ticks minus commissions and you were partly wrong because you thought the market would not be above 8650 or below 8500.
In this example, if the options expire when the futures are at 8511, you would make 94 ticks with the options strategy and you are even with the futures strategy. The futures needed to be 8605 for you to make 94 ticks. If at expiration the futures are at 8440, you would have lost 71 ticks on the futures strategy and in comparison, still would have made 34 ticks on the options strategy.
This is why I like options strategies, because even if you are wrong what you think the market will do, sometimes you can still make money. If you are right you do well, and if wrong, you might still make money. Read that again! When you are right you make money, and sometimes if you are wrong you can still make money. Compare that to a futures contract.... If the futures go 1 tick your way you make 1 tick and every tick against you, you lose 1 tick.
One last comment is that you can hold this until expiration, or get out of any or all of this position at any time.
Good Trading,
Howard Tyllas copyrighted 1/15/07
Futures trading involves the substantial risk of loss and may not be suitable for all investors.
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