My pal was a normally a mild-mannered sort – very reflective, always weighing the consequences rationally before acting. In short, a logical thinker.

Imagine my dismay when that one phrase, “trading options”, triggered this unprecedented tirade. You’d think I’d insulted his family or something even worse.

After a few seconds had passed, I realized the reason for my friend’s outburst. He, like so many other investors, had only lost money trading options.

Why? Because he’d never discovered the number one option trading secret: 3 out of 4 options expire worthless. You read that correctly, when you trade options as a buyer, you have a 25% chance of making money, and a 75% chance of losing money.

This is why professional traders and investors favor the option strategy of selling options, rather than buying them, in hopes that the trade will go their way.

“Wait a minute. How can all of those options just expire worthless? I’ve seen ads for 100’s of option strategies and trading systems on the internet. They can’t all be losing money.”

I had to smirk. Now I really had him thinking. He knew that I hadn’t yet told him the big “secret behind the secret”, but he couldn’t quite put his finger on it.

“I have one word for you, my doubting friend”, I said,…”Time”. “When you become an option seller, you have time working FOR you, instead of against you. The reason is simple – as puts and calls get closer and closer to their expiration date, they lose their time value, due to “time decay”, or theta, the Greek letter that option traders use to denote the % of change in time value of an option.”

This is true of any option, no matter if you’re buying or selling call options or put options, or using a covered call strategy. It’s one of the big secrets of options investing that doesn’t get written about too often.

Because of the power of time decay, you can actually guess wrong about the direction of the market, or a stock, and you’ll still make money selling a call option or put option, as opposed to the buyers on the other side of the trade, who not only have to guess the stock’s future price movement correctly, but must do it BEFORE the option expiration date.

This helps to explain why even conservative investors use the covered call strategy, which is widely considered one of the most conservative option trading strategies around.

To sell covered calls, you must own at least 100 shares of the underlying equity, since each call contract corresponds to 100 shares of the underlying stock.

This is a tool you can use to hedge your portfolio, and lower your risk, by receiving “call premium” money, which lowers your break-even cost basis.

Selling covered calls is a short-to-mid-term option strategy you can use to double and triple your yields on new stock purchases, and/or to earn more income from your existing portfolio.

Let’s be clear on this. There is no other option trading strategy that can outshine or even equal the profit generating potential of the sport of writing naked options. The term ‘sport’ is used here because those who practice this money making trading technique not only turn out fabulous profits but also have fun in the process. It is a fun, profitable but dangerous option trading sport that is mostly played by seasoned and skilled option players. That is, until the sport’s peril’s were tamed with the use of trading techniques that, while offering substantial safeguards to the player, still continued to offer high profitability ratios, albeit at slightly reduced rates. Having made it ‘investor safe’ has only slightly altered the profit potential of writing nakeds and certainly, without doubt, continues to be the premiere money making trading strategy in the options market.

 

The birth of the options market in recent decades spawned the creation of dozens of trading strategies and systems that is today being used not only by individual options traders but also by financial institutions. Stock options as an investment instrument is now widely employed as a safe and sound money strategy. The ability of options to give the investor a wide range of choices in stock market investment is what has made the options market grow by leaps and bounds over the last two or three decades. There are dozens of option trading systems being employed by individual investors as well as financial institutions. Each system is designed to accomplish a specific investment goal. A financial institution may use long put options to hedge its winnings in stocks that have appreciated in value, another investor may buy call options instead of stocks to enter a position in a security that has caught his fancy. Still another may sell calls against his stock holdings to generate income from his stock position, or what is now popularly known as covered call writing.

 

Trading strategies, techniques and systems available to the option trader are so numerous today that it would take a whole book to describe each and that would be just a brief description not a detailed explanation. It would be far beyond the scope of what we could cover in this short article. Most of the strategies are based on the principle of buying calls and puts or, variations of this strategy such as the use of spreads. The reason for the popularity of buying calls and puts and its variations is quite simple; limited or defined loss against the potential for unlimited and fabulous profits. This is what has driven thousands into the options trading game. But like everything else in life there is always a trade off. While the potential for fabulous profits against limited investment exists the reality of achieving such success is restricted. It’s almost like buying a lottery ticket with the potential for winning fabulous riches. Or putting it differently, it’s also akin to going to a casino and placing bets on gaming tables with the hope that at the end of the evening you will come out with more money than you came in. As we all know there are very few winners in casinos and that is why the gaming business offers tremendous profits for the operators.

 

But one can be an option trader and be in a similar position as the casino operator.  How? By being an option writer or seller instead of a buyer. For every option that is bought in the market, there must be a seller or writer of the option. These writers are the casinos in the options business. As the option seller you take the bets from the option buyers and since 75 to 80 percent of all options in the market expire worthless, you the seller pocket the premiums paid by the buyers when the options they bought expire worthless. For the benefit of those who are not familiar with gambling casinos, the winning odds of casinos over the betting player is only around 5 percent and yet they rake in profits from this business. Now imagine this, research and studies have shown that the option writer (seller) has better than 10 to 20 percent odds over the option buyer.

 

Option traders who successfully use the strategy of selling options consider themselves as having found the Holy Grail of Investments. And of all the variations in option selling strategies (just as many as there are in option buying), writing naked options is considered to be the Cadillac division. No other option selling system offers the profit potential of the naked writer.

 

So why aren’t there more option writers in the market? For two reasons:

 

 

 

 

 

It must be noted however, that option writing is fast gaining popularity among serious investors looking to grow their wealth at a steady, consistent and secure manner regardless of market or economic conditions. For those willing to venture into this lucrative field for long term capital appreciation don’t let the first reason above frighten you into inaction. There are many ways one can protect himself and conquer the element of ‘unlimited loss’ in writing nakeds. The author of this article is one of many successful naked option sellers. He has put out an e-book detailing a trading system that uses a three pronged strategy that trounces the so-called risk of loss to be almost neglible. Information about his system can be found at his web site.   

 

 

 

Option Strategy No. 1 – Buying Put Options

It is fairly easy to purchase put options. This option trading strategy can even be used in an IRA account as long as you have been authorized by your broker. You desire to select a stock, which you feel has a good chance of going down in price. Your risk will be limited to the cost of the put option. For example, stock XYZ is currently trading at $50 per share and you buy a put option on XYZ with an expiration date of two month later with a strike price of $50. If the stock drops from $50 to $40, your put option would be worth $10 per share.

Option Trading Strategy No. 2 – Buying Bear Put Spread

Buying a put spread is a little more complicated than just buying a put option but gives you the benefit of reducing your cost but caps your profit. A put spread is characterized by the trading of two same month expiration put options, buying one at a given strike price and selling the other put option at a strike price lower than the purchased put option. You want to pick a stock that you believe will be falling in value. Your risk will be limited to the cost of the put spread. As an example, if we purchase the put option as listed above but also sold a put option with a strike price of $45. In this example, should the stock plunge to $40, you would profit $5 per share ($50 strike price – $45 strike price). And while you are making less per share, your savings comes in the fact that the cost of buying the put option outright would be much higher than the initial cost for the bear put spread.

Option Trading Strategy No. 3 – Married Put

Risk can be minimized by utilizing a married put, which is a hedging strategy. This strategy consists of purchasing a stock that you believe will appreciate in value and buying a put option at the same time to minimize any losses due to adverse market movement. You might have heard the saying that there is always a bull market going on somewhere. In order to benefit from this strategy find out what business sectors and securities go against the grain and appreciate in a bear market. Next you buy the stocks you chose and protect your investment by buying a put option to limit your losses if the stock goes south.

In conclusion, you can still make big profits in bear markets by looking for stocks that you think are going to fall in price and buying a put option or a bear put spread. Alternatively, you could buy a married put on a stock in a sector you believe is going to appreciate, thus minimizing your risk. In addition to buying options on stocks, you can also buy put options on exchange traded funds or index options. Exchange traded funds let you invest in global markets, commodities and even currencies. It is possible to receive a large profit in a bear market. However, it is vital to comprehend the details of the option strategies, choose the correct stock, exchange traded fund or index option, and make use of a proven tactic and begin.

Disclaimer: This article should not be used as financial advice; it is only for informational purposes. Be sure to contact your financial advisor prior to making any decisions on investing.