One my favorite parts of running OptionSizzle is engaging and interacting with all the different types of investors from all over the world. It brings a lot of joy to me to be able to help them in their quest to build wealth. However, sometimes I feel when they reach out, they’ve got so many preconceived notions about how options should be traded…along with a list of Do’s and Don’ts, that aren’t always logical.

1. Putting Context Behind Your Options
Strategy

2. One my favorite parts of running OptionSizzle is
engaging and interacting with all the different
types of investors from all over the world. It
brings a lot of joy to me to be able to help them
in their quest to build wealth.

3. However, sometimes I feel when they reach out,
they’ve got so many preconceived notions about
how options should be traded…along with a list
of Do’s and Don’ts, that aren’t always logical.

4. For example, I get a ton of responses on social
media whenever I discuss the topic of selling
option premium. For whatever reason, they
believe that selling premium is a widow maker.
I’m not sure where this belief stems from…but
it’s pretty silly.

5. Let me show you why.

6. On October 3, 2014, Tesla Motors closed at
$255.21. Let’s say you had a bullish bias on the
stock over the next 5 weeks and wanted to
express that by buying a call spread, the
November $265/$275 call spread.

7. Using mid-price (average between the bid and
ask price), these were the values:
NOV $265 calls: $12.90
NOV $275 calls: $9.30

8. So if you bought the NOV $265 call and sold the
NOV $275 call for $9.30, the spread would cost
$3.60.
(Note: This is not a trade recommendation and
in a live market it’s unlikely that you’d get filled
at the mid price…this is just an example)

9. What is your belief with owning this spread?

10. Well, to break even on the trade at expiration,
we would need Tesla to close at least $3.65
above $265, which is $268.60.

11. Since this is spread was purchased, the
maximum risk is $3.60 per contract.

12. The trade is risking $3.60 to make $6.40. This is
derived by taking the max value of the spread,
$10, and subtracting the premium spent on the
trade.

13. Makes sense?

14. Good…Moving On

15. I know that some savvy option investors already
know this…but what if I were to tell you that you
could replicate this same position by selling
premium…here’s how:

16. By selling the NOV $275/$265 put spread.

17. The mid-price for the NOV $275 put is $29.13
The mid-price for the Nov $265 put is $22.73

18. By selling this ITM put spread, you’d receive a
premium of $6.40.

19. So what is this spread saying?

20. In order to break even on the trade at
expiration, we would need Tesla to close $6.40
below the $275 calls that were sold, which gives
a price of $268.60.

21. In this example, $6.40 were collected on a $10
spread…which means the max risk is $3.60.

22. Now, if you look at both examples again, you’ll
notice something very interesting…

23. They are both the same trade in respect to
break even points, risk and reward. One is done
through buying an OTM call spread, while the
other is done by selling an ITM put spread.

24. This isn’t magic…this is how options work. After
all, if one was more expensive than the
other…you’d simply sell the more expensive
spread and buy the cheaper spread for an
instant profit.

25. In options jargon these are called “synthetics”
or replication.

26. Here are some more examples:
A long stock position: Has “undefined” profit
potential on the upside and defined risk on the
downside (a stock can only go to zero).

27. How do we do achieve this with options? Well, a
long call option has “undefined” profit
potential…but what about the defined risk on
the downside? That can be achieved by selling a
put.

28. Going back to Tesla, if you were long stock at
$255…the synthetic equivalent would be long
the $255 call and short the $255 put.

29. A short stock position: Has defined profit
potential towards the downside and
“undefined” risk towards the upside. To
replicate this with options we would just using a
combination of calls and puts that have this
same risk profile.

30. For example, if you’re short Tesla at $255…the
synthetic equivalent would be long the $255 put
and short the $255 call.

31. Long Stock Long Call + Short Put
Short Stock Long Put + Short Call

32. By using the above table, we can mix and match
stock and options to create other replications.

33. For example, long stock and a short call is known
as a covered call…or synthetic put.

34. Long Stock +
Short Call
Long Call + Short Put (the
embedded long call is canceled
by the short call)

35. I could keep going…but I think you get the
picture.

36. You see, there is a relationship between stocks
and options…longs and shorts…calls and
puts…they can all be replicated. This ideology
that you’ve got to stick to only buying premium
is silly once you understand these relationships.
With that said, being solely a premium seller is
also silly.

37. Professional traders understand this…for the
most part, they don’t care if a stock is moving
higher or lower…all they want is increased
volatility…because that’s what creates
opportunities in their eyes.

38. With that said, your focus should be on the
opportunities in front of you. Too many people
are focused the premium buying vs. premium
selling debate. It’s like democrat vs.
republican…the reality is it’s all the same.

39. Unfortunately, we as people sometimes put our
attention on the wrong things.

40. So What’s important then?

41. Idea Generation: This can be driven by
fundamental, technical, unusual options activity,
event-driven and from views on volatility to
name a few. If you’re having difficulty generating
ideas, I suggest you check out my free report on
unusual options activity.

42. Options Landscape: Are the bid/ask spreads
competitive? Are options relatively cheap or
expensive? After addressing these questions,
then you can start thinking about an options
strategy.

43. Identify The Type of Trade: Is this a binary
event? A technical play? A long term or near
term play? An earnings play? By answering this
question you’ll get a better feel for what you
should be risking, time needed and how you
should be sizing the position.

44. Risk & Position Management: Now, if you’ve
sized the position correctly, a lot of the hard
work is out of the way in regards to handling
losses. For many option investors, handling
winning trades is a lot harder. I have different
approaches, depending on whether I sold or
bought premium.

45. As I’ve mentioned before, options are just a
vehicle and an options strategy is an expression
of a trade idea. As you gain more experience,
you’ll learn what works best for you and what
doesn’t.

46. You’ll want to focus on your A+ setups as much
as possible…and have the discipline to not
overtrade or put on trades out of boredom.
There are periods where trading options can be
full of excitement…others where there isn’t
much going on and you’ll need to be patient.

47. Remember, cash is also a position and a luxury
when you manage money for yourself.

48. Choosing when to be more active or less active
comes with understanding opportunities when
they do or do not arise.

49. It’s a myth that you have to be fully invested at
all times and something financial professionals
have told you for many years because they only
get paid if your money is invested.

50. With that said, you’ve got to put everything into
context. Although I’m an advocate about selling
premium, certain conditions apply. The same
can be said about being long premium. They
both can work if the right conditions are met.

51. For example, when I’m selling premium…I’m
look for options that are relatively rich, the stock
options need to offer good liquidity so I’m not
chopped up in the entry and exit.

52. Also, I take into account the price of the
underlying stock and the type of risk I’m willing
to expose myself in. Sometimes short strangles
can be justified…other times I’ll use a structure a
trade to define my overall risk.

53. In fact, The SPX Method is a detailed course that
teaches you a step by step blueprint on how to
make the market beat you. By following specific
parameters you’ll be provided with the best
chances to create profits on a weekly basis.

54. However, certain conditions need to be met. For
example, if the VIX is above 15…we’ll look to
entering one of our trades on Wednesday
morning…but it’s near 17.50…we’ll put it on
Wednesday afternoon…if it’s near 20, we’ll wait
a day and put in on Thursday.

55. Bottom line, the opportunities must fit the
parameters.

56. In conclusion, the premium buying vs. premium
selling debate is futile context. My belief and my
approach is to utilize both. Money can be made
and lost in both fashions. What’s important is
your process and execution.

57. Too many times investors get caught up in
“strategies” and options marketing jargon…most
strategies are just way to define risk. A strategy
will only work if the right conditions are
met…that’s what OptionSIZZLE tries to teach
you.

58. I believe that selling premium provides the best
probabilities of success. However, I understand
that buying options offer that potential for a
home run trade, and that you should have some
of these type of plays on as well.

59. Focus on what’s in front of you and you’ll never
look back.

60. What are your thoughts on this great debate? I’d
love to hear from you in the comments section
below.

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