CONSTRAINING CHAOS – PART THREE
The main strategy for selling out-of-the-money options will be using strangles, straddles and naked options. I must warn you that these strategies are NOT for the beginner. The information I am providing here is for educational purposes only and should ONLY be used with trading a paper account until familiar.
Here are the strategies I mentioned in Part Two:
1. The Split
If you have a contract which you’ve sold and it is going against you to the point of causing some discomfort, the Split is the most common way to move an option that is too close in-the-money by splitting it up into two contracts which are further out-of-the-money. The idea here – as with all these strategies listed – is that we want all of our short options to live out in the 70-90% percentile of expiring worthless.
Example: Say I sold an out-of-the-money option in $GPRO – the Jan4 Weekly 47.50 strike Put for around $1.00. As you can see, the $47.50 strike put is now close to the money, so I want to close it out for approximately $2.00, then sell the $50 strike Call for approximately $1.00 and the $45.50 strike put for approximately $1.00. Now, I’ve “split” my position to move out to wider strikes and I’ve sold the exact amount of premium I lost on the original 47.50 put.
For your contract size, it will be the exactly the same for both options. So, if you have 10 contracts on the 47.50 put, after you close it out, you will then sell 10 of the $50 strike calls and 10 of the 45.50 strike puts.
2. The Swap
Sometimes price will move against you rapidly and unexpectedly. When you are short options, this is your worst enemy. In this situation, you’ll want to keep a level-head and work off of your support and resistance lines carefully. If price rips through support or resistance and rips through your strike price, you’ll want to do a “swap” – that is, if sold a put and it is against you, you will swap it out for a call of equal price, or vice-verse.
Example: If you are holding the short $47.50 call that you sold for $1.00, and price is moving through that level and it looks like it will hold $47.50 and move higher, you can close out the call for approximately $2.00 and sell the same number of 47.50 puts for $2.00 – making an even exchange of premium.
3. The Double Down
Just as you can move options to different strike prices for the same amount of money, there is another variable that you can use in your favor: Contract sizing.
Not all trades are the same, so sometimes a trader’s confidence level is a bit lower on a less-than-optimal setup. In this case, you would want to go in a HALF your normal contract size, so as to give yourself room if price goes against you.
When you place a trade at half your normal contract size, you are anticipating the trade going against you and you’ve plan a step ahead of price action. This is one of my favorite strategies because it gives me room to be wrong, but if I’m immediately right, then I take quick profits on half my normal contract size and move on to the next trade idea.
Example: If you sold half your normal size of the $47.50 calls for $1.00 and they are now $2.00 – and you sold only 10 contracts. You could close these out and sell 20 of the $50 strike calls for $1.00, this would equal the same premium you were trying to collect.
4. The Roll Out
This is the commonly used of all the strategies. It simply means rolling one option which might be close to the money for another one of equal price further out in time. Since you are selling something further out in time, the strike price will be further away, thus completing your objective of getting your position out to the 70-90% percentile of success.
The goal with each of these strategies is to practice them until they become a reflex. The ultimate goal is to use your knowledge of price action to plan two or three moves ahead of where price is currently so you always have a plan of action when things go against you.
Again, I need to stress that these are high-margin, advanced techniques that should be practiced thoroughly with a demo account because they are very risky. Please be careful out there.
I hope this series was helpful. Please check out my video course on options, where we go into detail regarding these strategies and many more. http://optionboost.com