Increase the odds of Success in Commodity Option Selling
The practice of option selling is a controversial strategy for commodity option traders to partake in. Many brokerage firms outright forbid the practice; others allow it, but there are often strings attached. However, there are a limited number of brokerage services that recognize despite the challenges of option selling, it likely offers the highest long-term prospects for successful trading. Accordingly, such brokers give their clients the freedom to implement a short option strategy. We are a part of the minority commodity brokers that believe our clients should be given the opportunity to sell options without hassle. Nevertheless, option selling is far from an “easy-money” venture; there is a reason many brokerage firms shy away from option selling.
What is Option Selling?
Option sellers are in the business of collecting premium, much like an insurance company, under the assertion that in the long run the premium collected should outweigh any potential payouts. In a nutshell, an option seller is accepting the risk of the futures market trading beyond the strike price of an option, in exchange for income. For instance, a trader selling a $60 crude call for $500 is collecting $500 with the expectation that the price of oil will be below $60 at option expiration. If oil is above $60, the trader is exposed to risk similar to being short a futures contract from $60.00.
The premise of option selling is based on the assumption that more options than not expire worthless, which has been suggested by several studies including one conducted by the Chicago Mercantile Exchange. Unfortunately, similar to insurance companies who are sometimes forced to honor their policies on excessive claims, commodity option sellers are vulnerable to monster market moves than can be potentially account threatening. Preventing such disasters ultimately come down to timing of entry along with a good understanding of futures market volatility, market sentiment, and market knowledge. Additionally, experience, instinct and, of course, luck will also come into play. Yet, in my judgment option selling is a superior strategy in the long run.