So you just sold an option? Congratulations. You have just made a sale. Well, yes, but what happens if the market moves against you after your sale has been completed?
Of course – your position is now ‘in the money, which means that you must execute your risk management strategy. If it is not (or not to the required standards), you may find yourself with a loss instead of again.
Table of Contents
Hedging
Firstly, you should immediately place an order in your broker’s trading platform that will be like an insurance policy against any adverse market movement (i.e. ‘hedging’).
This process differs between brokers and can sometimes be a little time consuming, especially if you also need to fix your position.
Whilst this hedging process is happening, the next thing that any competent options trader should do is to close their original position and lock in their gain; we call this ‘fixing’ or ‘being flat’.
It can take a few moments longer depending on the trading volume in the markets – again, sometimes different for each broker and its platform.
However, it is always best not to leave your order too late, as slippage may occur due to market volatility.
Before making a suitable escape from the trade altogether, the final step should include watching out for adverse gapping moves.
If a large gap opens up against you, your position may be under extreme duress.
Do not make a hasty decision to close the entire trade until you have seen what happens next – sometimes, a quick fade is all that is required to ‘fill’ or break even on this trade.
Still, sometimes more certain action must be taken, including closing the position altogether.
Day trading capital
Always ensure that any successful trades are treated as ‘capital’ and never become part of your day trading capital.
In other words, if you made 10% on two lots of 100k (£100k/$150k), always bank the full £200k.
Keep those profits separate from your own money so that you can use them for subsequent trades without contaminating your account and so that you can monitor your profitability accordingly.
Always remember to take a few minutes each day to analyse the markets and determine what steps you need to take tomorrow to avoid losing them – or even better, if they are still ‘in play’, increase the value.
Some professional traders have found this new environment too frenetic and unstable; they prefer not to play in an arena where money depends on luck rather than skill.
However, there are still one-way pros to find success: options.
Ratio writing
The following most crucial technique is called ratio writing. It can be used when bearish on an underlying asset, such as the S&P 500 index (SPX).
Essentially, this strategy involves selling more out-of-the-money call options than in-the-money ones.
If executed perfectly, this technique should (over the long run) generate a credit for the trader.
Put spread
If you hate figuring out market direction, then put spreads may be perfect for you.
These trades can make money with either side of a stock going up or down; furthermore, they’re easily set up and don’t require much capital to get started.
Essentially, a bull put spread requires buying several at-the-money puts and selling twice as many out-of-the-money contracts above their strike price.
The result is that you end with a positive debit from making this trade.
Calendar spread
A calendar spread is a way of trading multiple contracts for the same position but with different expiration months.
It might not sound obvious at first, but like most things option-related, it’s pretty simple.
For example, if you buy December wheat options and sell March ones (both calls and puts are allowed), you have done nothing more than create a calendar spread using options on futures.
This trade will generate positive cash flow shortly after opening it if executed precisely correctly.
For more info, link to UK options trading brokers.
