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  1. What is Selling Options Premium? Selling Options Premium is a general term that refers to Options Selling strategies (as opposite to Options Buying strategies). Some examples of Options Selling strategies include: Iron Condor Butterfly Spread Short Straddle Short Strangle Calendar Spread Some examples of Options Buying strategies include: Long Call Long Put Long Straddle Long Strangle Reverse Iron Condor Please note that getting a credit or paying a debit is not what defines a strategy. A butterfly spread can be done with credit (Iron Butterfly) or debit (regular Butterfly). What is typical for Options Selling strategies is the fact that they are usually theta positive, gamma negative, vega negative. Myths vs. Reality Myth 80% of the options expire worthless, so selling them gives you an edge. Reality According to CBOE, approximately 30%-35% of options expire worthless. But more importantly, percentage of options expiring worthless is irrelevant as we demonstrated in our article Do 80% Of Options Expire Worthless? This is an argument used by many amateur traders, and also by some options trading "gurus" to attract new subscribers. ---------------------------------- Myth Options Selling has high probability of success (80-90% winning ratio). Reality First, not all options selling strategies have high probability of success and high winning ratio. For example, butterfly spreads have much lower probability (but better risk/reward). When referring to 80%+ winning ratio, it usually implies selling low delta credit spreads or iron condors. But what is important is not that you win 80% of the time, but what happens when you lose? If you make 5% on winning trades but lose 60% on losing trades, you are still losing money, right? ---------------------------------- Myth Options selling has a lousy risk/reward. It's like picking up pennies in front of a steamroller. Reality This myth is an opposite of the previous one, used by options selling opponents. And again, risk/reward has inverse correlation to probability of success. Good risk/reward = low probability of success, and vice versa. ---------------------------------- Myth Options selling allows you to have extra income (they are sometimes called "income producing strategies"). Reality A BIG FALSE. The fact that you are getting cash upfront doesn't mean that cash will necessarily stay in your account. If the position goes against you, you will need to pay more to close it. If you want stable and reliable income, buy T-bills, dividend paying stocks etc. Options are NOT for income. ---------------------------------- Myth If I sell options with 10 deltas, I have 90% probability of success. Reality This claim completely ignores Implied Volatility changes. This is especially true when selling puts. If the underlying starts to tank, IV will start to increase and the delta will start to increase at much higher pace, amplifying the losses. ---------------------------------- Myth Selling weekly options will produce the best results due to higher positive theta. Reality Higher positive theta comes with higher negative gamma. Those strategies are much more sensitive to underlying move, and the losses are much harder to control. ---------------------------------- Myth 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. Reality While this is true, it ignores the size of the winners in those three scenarios vs. the size of the losers if the stock moves sharply against you. ---------------------------------- Myth One of the most important aspects of selling premium is the positive theta. Reality Yes, but those positions usually also have negative gamma and negative vega. In case of a big move (especially down move) the negative gamma and negative vega will play much bigger role than positive theta. It is very misleading to look at one Greek and ignore the others. ---------------------------------- Myth: A good way to capitalize on volatility crushing after earnings is to sell premium. Reality: It is true that Implied Volatility increases before earnings and crashes after earnings. However, if the stock moves more than "expected" after earnings, selling premium will be a losing strategy because the gamma losses will outpace the vega gains. How NOT To Trade NFLX Earnings explains the concept. Does Selling Options Premium Work Or Not? The short answer is: it works most of the time - till it doesn't. And when it stops working, the losses can be devastating. Just ask Victor Niederhoffer, Karen Supertrader, James Cordier and many others. The main reason Selling Options works in the long term has nothing to do with 80% of options expire worthless, 90% winning ratio or other myths. The main reason it works is that Implied Volatility (IV) tend to be higher on average than Historical Volatility (HV), especially on indexes. When using a strategy, please make sure you understand why it works or doesn't work in the long term. Some options "gurus" insist that selling options is the only way to be profitable. They are trying to prove that options buying doesn't work - and we prove them wrong time after time for the last seven years. Selling options has its advantages and disadvantages, so is buying options. It's not about the strategy, it's how you use it. Risk management and positions sizing are the key. Not surprisingly, none of those options selling gurus is willing to provide their track record. If you do insist to sell options, here are few simple rules that might help you to reduce the risk: Always look at risk/reward. Don't be attracted to high probability low delta options. Those trades might work well for many months (or even years), but inevitable will eventually happen. They are a true definition of "picking up pennies in front of a steamroller". Never underestimate the risks of leverage, especially when you sell naked options. Be very careful with selling weekly options due to high negative gamma. Be aware that earnings are a binary event if you decide to sell options before earnings and hold them through the event. Never sell naked options on individual stocks. The risk of unexpected event like acquisition, earnings warning, analyst upgrade/downgrade is too high. Conclusion Selling Options Premium can work, and it should be part of well diversified options portfolio. However, in my opinion, you should always have other strategies to balance your portfolio and control risk. Having only options selling trades in your options portfolio is a certain path to ruin. Just imagine what will happen if you have a portfolio full of gamma negative vega negative trades and S&P 500 goes down 5-10% (not to mention a sharper correction). Years of small gains will be gone. Related articles: Karen The Supertrader: Myth Or Reality? Karen Supertrader: Too Good To Be True? How To Blow Up Your Account The Spectacular Fall Of LJM Preservation And Growth James Cordier: Another Options Selling Firm Goes Bust How NOT To Trade NFLX Earnings
  2. It's All About Leverage and Margin The author is mentioning some low priced gold options: "So, you're recommending the August $1,100 puts. That gets us out there far enough, decent premium, $500. The margin is less than 2 to 1. So, you're taking in about $500-600 for each one you sell. The margin requirement is about $800-900. It's a quite small margin requirement to hold this position, and it makes it quite easy to put in a portfolio. Once you put it on, if that value does start decaying, the margin requirement goes away with it. So, your margin requirement drops" What Mt. Cordier forgets to mention is that if the position goes against you, the margin actually increases. It can double, or triple, in a very short time period. Also, one contract gives you control on $120,000+ of gold futures. Based on margin requirements, that's over 1:100 leverage. The article implies that those strategies are almost free money. And then there is no mentioning of risks at all. ZERO. Anyone who was reading the article could see this coming. The writing was on the wall. But the really scary part came about two weeks later. Catastrophic Loss Event On November 15, 2018, notified its investors in an email entitled “Catastrophic Loss Event” that it not only lost all their money, but that they would also owe money to Intl FC Stone for margin calls. According to, they lost a substantial portion of their investors’ assets due to a short call position in natural gas that, according to “was so fast and intense that it overwhelmed all risk measures in place.” Mr. Cordier then informed investors that they have a debit balance in their accounts which they need to bring back to zero by paying INTL FC Stone the difference. So, in addition to trying to process the news all their money is gone, they also have INTL FC Stone breathing down their necks demanding they pay the money they owe for its margin calls. According to Investors Watchdog,Tampa-based touts itself as premier and highly experienced commodities options trading firm. The firm’s president and head trader, James Cordier, explained in a recent interview: “Our goal is to take an aggressive vehicle and manage it conservatively.” Unfortunately, Mr. Cordier did not trade options conservatively. It traded “naked” rather than “covered” options, leaving investors subject to unlimited exposure. This unlimited exposure is what caused to lose all their money and more in the last few days. Thus, and its principals negligently engaged in a risky trading strategy that was unsuitable for its clients and breached its fiduciary duties to them by putting its interests ahead of its clients. What Happened? This is a pretty good explanation from Palisade Research: James Cordier blew himself up by selling naked call options on Natural Gas. . . Mr. Cordier with his expert financial opinion thought it was wise to sell naked call options on Natural Gas. The thesis was that the 2018 winter was expected warmer than previously thought. And with the over-supplies of Nat Gas coming in from higher prices – Nat Gas would weaken over the next few months. So Mr. Cordier made a bearish bet on Nat Gas by writing naked call options. Remember – a naked call option is when a speculator writes (sells) a call option on a security without ownership of that security. It is one of the riskiest options strategies because it carries unlimited risk. . . He thought that he could take advantage of the ‘peak’ natural gas price two ways. First – since Nat Gas prices were up recently, he could sell options for higher premiums as bullish investors came in. Giving him more upfront profits. And Second – he believed that Nat Gas prices peaked. And would soon turn south. Which meant the options he sold would expire – and he would be off the hook. And at the very least – he didn’t think Nat Gas prices were set to go that much higher. But they did. . . Nat Gas shot up nearly 20% in a single afternoon last week – to its highest price since 2014. Some say that the added buying sparked a ‘short-squeeze’ – when a heavily shorted stock or commodity moves sharply higher, forcing more short sellers to close out their short positions. Soon after the smoke cleared he had to break the news to investors and clients. He sent a letter – and made a video apology (you can watch it below) – telling everyone about the unfortunate “catastrophic” situation. The Numbers Our contributor Chris Welsh provided some real numbers how those catastrophic losses were possible: Traditionally you can get about 16x leverage trading oil futures contracts, based on the margin requirements (though with oils recent major drop offs those margin requirements are now higher). Using some actual older prices, this means to open a $90,000 oil and gas position, each account would have to only invest $5,610. So if an account had $56,100 in it, he could purchase a position worth $900,000. Then if the price of oil goes up 1% (and he's long) then his investment would go up close to 16%. This is not abnormal, and exists in the normal option trading we do too. However, that is just really, really, really poor risk management to use that much leverage. Which gets us back to those pesky margin requirements. Margin is NOT static. So If I bought that $90,000 position for $5,610 of margin, when the price starts moving against me, I have to put up more margin, because the risk to the position increases. It's not uncommon to see margin requirements double, or triple, in a very short time period. Well his margin requirements went THROUGH THE ROOF. That $100,000 account now had a margin requirement of over $100,000. This means he's now subject to a margin call and has to either liquidate positions or put more cash up. He did neither, which means all those accounts got forcible liquidated....but after the prices had moved even more. Now that $100,000 account has a value of -$50,000, of which the owner is responsible for putting up. And since these are separately managed accounts, that means each separate "investor" is responsible for their share. These things only happen to people that don't understand risk or don't care or are idiots or are greedy idiots....or fill in your superlative here. One of clients shared his statement for 1mln portfolio where you can see all his positions. The level of leverage is just scary. Is Selling Options Really Superior? In his interview from couple years ago, James Cordier said: "Once I realized that 80% of them expire worthless I started selling commodity options instead of buying them." Not only this is factually not true (according to CBOE, approximately 30%-35% of options expire worthless), but this is also completely irrelevant, as we demonstrated in our article Do 80% Of Options Expire Worthless? This is an argument used by many amateur traders, and also by some options trading "gurus" to attract new subscribers. Even if the "80% expire worthless" myth was true, it doesn't matter - if you gain little when options expire worthless but lose big when they go in the money, your bottom line is still negative. But the most important thing is that most options are not held till expiration. Selling options has its advantages and disadvantages, so is buying options. It's not about the strategy, it's how you use it. Saying that 80% of the options expire worthless is like saying that 100% of the people eventually die. "Experts" like James Cordier should know better. And maybe he does - but those claims definitely helped him to attract new money from people who don't know any better. The fact that those people are considered gurus and are featured on CNBC, WSJ, Bloomberg and MarketWatch is scary. The Lessons James Cordier is obviously not the first money manager who blew up his clients accounts (or experienced catastrophic losses). Victor Niederhoffer, Karen Supertrader, LJM Preservation And Growth Fund.. there are probably many others less famous. Naked options by themselves are not necessarily a bad thing. The problem is leverage and position sizing. If implemented correctly, naked options can make money in the long term. But if you overleverage, you just cannot recover from the inevitable occasional losses. We warned our readers about the dangers of naked options and leverage on several occasions. As our contributor Jesse Blom mentioned: All 3 of these examples, and the newest one, share the common element of leverage. Excessive leverage, and also lack of diversification. Strategies like naked option selling work fine if you ignore margin requirement and view risk based on notional exposure. Parametric's VRP paper shows how a SPX naked strangle has been less risky than owning the underlying index when sized based on notional exposure. For example, that means selling 1 SPX strangle per ~$265,000 of capital today. But in this case, James Cordier took commodity futures (NG) which is itself a leveraged instrument, and applied even more leverage using naked options. Here are the elements that contributed to the failure: Using highly leveraged instrument like Natural Gas futures. Writing naked options that have theoretically unlimited risk. Using leverage on already leveraged instrument. No diversification. Using no hedging or risk management. The result was disastrous and inevitable. It always is when someone is using extreme leverage like this one. As one of our members wrote: "People see these crazy returns and think these personalities are doing something magical when really most are just levered to the hilt and taking dumb risk when there are several reasonable ways to hedge". One macro hedge fund founder faulted both Cordier and his investors for the outcome. “The nature of the strategy is that you make a little bit of money until you blow up. The probability of losing it all is fairly significant. With derivative contracts — if you don’t understand them — you really need to give money to someone you trust, and to couple of them. Have some checks and balances.” “basically took advantage of guys who didn’t know any better. I instantly thought of my grandmother, my grandfather. I honestly was thrown when I heard about it.” Conclusion To add insult on injury, it turns out that James Cordier enrolled his clients into managed accounts and not a fund. This was the reason why his clients not only have lost all their money, but that they also owe money to their broker for margin calls. As Chris explained: The media keeps referring to this as a "hedge fund." But that is NOT what it was. It was 290 separately managed accounts, all trading the same strategy. Whereas a hedge fund is an actual "company," typically a limited partnership or limited liability company, that insulates investors from losing more than they invest (unless specifically structured to make investors liable, which is VERY rarely done). The wheels started coming off here. Since these are block accounts, that means EACH client owns their own accounts and is responsible for them. So if he loses MORE than is available in the account, the account owner gets the bill....not the fund "manager." Should we feel sorry for the Mr. Cordier? There is no sympathy from Josh Brown, the Reformed Broker: Some people made me aware of how he was marketing this fund. He called it a retirement strategy. It’s not a retirement strategy, it’s speculation. I don’t feel bad for James Cordier, or his “clients.” Taking in premiums from selling calls – picking up nickels – and having no idea of the potential for a blow-up is the most childish thing I’ve ever heard. No, the laws of risk and reward are not repealed just because someone sounds sophisticated when discussing derivatives. Risk cannot be eliminated, only transformed. This man sold investors a lie. And now he compounds it with a new lie – “a rogue wave came along and capsized us!” GMAFB. Google this guy’s sales pitch when you get a chance. If your strategy bets on the movement of commodities and it isn’t durable enough to survive the movement of commodities, perhaps you have no business managing money in the first place. So no, no sympathy. Fuck you and your cufflinks too. “The problem with experts is that they do not know what they do not know.” ― Nassim Nicholas Taleb. Related articles: How To Blow Up Your Account Karen The Supertrader: Myth Or Reality? Karen Supertrader: Too Good To Be True? The Spectacular Fall Of LJM Preservation And Growth
  3. What is the Truth? Is it true? Do 80% of all options REALLY expire worthless? Are 80% of all options buyers automatically losers which makes 80% of all options writers automatically winners in the options market without any risk? According to The Chicago Board Options Exchange (CBOE) here are the facts: Approximately 10% of options are exercised (The trader takes advantage of their right to buy or sell the stock). Around 55%-60% of option positions are closed prior to expiration. Approximately 30%-35% of options expire worthless. The CBOE goes on to point out that having an option expire worthless says nothing about the profitability of the strategy that it may have been part of: Multi-legged strategies can often require that one leg or more expire worthless although the strategy as a whole is profitable. Option positions closed prior to expiration may be profitable or unprofitable. Options that expire worthless may not be unprofitable if they were part of a strategy that involved other securities such as covered call writing. Only About 30% of Options Expire Worthless? What does it mean? ABSOLUTELY NOTHING! It doesn't mean that when you buy options, you automatically have 70% chance of winning, it also doesn't mean that if you write options, you only have 30% chance of winning. Here are some of the arguments used by different options gurus in order to separate you from your hard earned money: BE THE HOUSE – Not the Gambler! Be the insurance company and win 90% of the time! Get stable and consistent monthly income! Get 90% winning ratio with our strategy! Those arguments have no basis in reality. Insurance companies can lose significant amounts of money during periods of national disasters. Monthly income can become monthly loss during periods of high volatility. And so on.. If you are not a member yet, you can join our forum discussions for answers to all your options questions. Advantages of Options Selling Opportunity for monthly cash flow with high annualized returns. Opportunity to buy stocks at lower prices via naked puts strategy. Over the long term, Implied Volatility tends to be higher than Historical Volatility. Downside protection for put sellers or covered calls sellers. Options sellers tend to have a higher win rate (but a lower rate of return). Covered call writers may also capture dividends. Opportunities to trade in self-directed IRA accounts, especially covered call writing. Disadvantages of Options Selling Money can be lost is stock price dips below the breakeven. Profit potential is limited by the strike price. Assignment risk (may have to buy or sell shares). There is a learning curve and time commitment. In many cases, risk/reward is not favorable (you risk much more than you can gain). When using strategies like Iron Condors, one bad month can wipe out months of good gains. Why it doesn't matter Those who suggest that 80% of options expire worthless assume that if an option expires in the money, it automatically means a win for options buyers, which isn't true. If you buy a deep in the money option and the underlying stock moves against you, your options would still end up losing money even if it is still in the money by expiration! Ultimately, it is the direction of the underlying stock that determines if you end up profitable. How about hedging? If you bought options as part of overall portfolio using strategy like Protective Put, and your options expired worthless, is it necessarily a bad thing? Not if you stock doubled in value while you held those protective puts. And one final example: consider a strangle seller who sells options (both puts and calls) on high volatility stocks before earnings. He can gain $100 four times in a raw when the stock doesn't move in the money, but lose $1,000 during a cycle when the stock moved big time and one of the options became deep in the money. In this case, 9 out of 10 of the options expired worthless, but he still lost money. Even if the "80% expire worthless" myth was true, it doesn't matter - if you gain little when options expire worthless but lose big when they go in the money, your bottom line is still negative. But the most important thing is that most options are not held till expiration. Conclusion Percentage of options expiring worthless is completely useless to options traders. This is NOT what should impact your decision to become an options buyer or options seller. The only way to determine which options strategy suits you is by really learning about them, their reward risk ratios, practicing them and understanding which approach best conforms to your investment objectives, trading style and risk appetite. Options is risky no matter if you are an options buyer or seller, don't let anyone tell you otherwise. There is no such thing as becoming "banker" in the options market. Understand the risks of options trading and you will be profitable. Related Articles: Are Debit Spreads Better Than Credit Spreads? Selling Naked Put Options What Is The Best Options Strategy? The Road Not Taken Are You Ready For The Learning Curve? Can you double your account every six months? If you are ready to start your journey AND make a long term commitment to be a student of the markets: Start Your Free Trial