February 6, 2016

Selling premium (options)

The term “selling premium” refers to selling options. There are many benefits to selling premium as opposed to buying premium, but there are environments where each strategy can flourish.

At tastytrade.com, we prefer to sell premium to give ourselves the best opportunity for success. From a price direction perspective, when selling premium we can win in three scenarios: if the stock price stays the same, moves against us slightly or moves in our favor. When buying premium however, we can only win in one scenario, and that is if the stock price moves in our favor fast enough. Bringing IV into the equation opens up another dimension in which we can profit. In low IV environments we may look to buy premium and hope for an IV expansion, and in high IV environments we look to sell premium in anticipation of a contraction in IV.

One of the most important aspects of selling premium is the positive theta value that results. Theta is the time decay of option premium. When theta is positive, the option decay is working favorably for the premium seller. When theta is negative, the option decay is working against the premium buyer. Theta is a nonlinear value, and exponentially increases the closer we get to the option’s expiration. Selling premium is our primary strategy because it ensures that our portfolio theta value remains high, and we slowly collect premium on a day-to-day basis. As long as our short strikes stay within our specified profit range, we will extract theta each day and have a lot more control over our profitability.

Read more at https://www.tastytrade.com/tt/learn

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