Option Selling: How Unlimited are Its Risks?

Options are among the most interesting instruments in financial markets. It is believed that the trader takes on unlimited risks when selling an option. Head of the Derivatives Trading Department within the Masterforex-V Trading Academy successfully shattered the myth of 'unlimited risks of option selling'.

Most classical authors on option trading have no practical experience of trading. This is why often theory is far from practice, including the myth of unlimited risks of option selling. In fact, risks are not limited only if we don't limit them ourselves! Indeed, most classical writers don't say that the option you sold could be bought back... this way annulling your obligations.

Let's look at a situation with purchase of futures:

 

Suppose, we buy futures at 1.3. If the price rises, we'll be in the profits. If the price falls, we'll be in the loss and our risk will be unlimited unless a stop order is placed. So, our risk is unlimited only if we don't limit it.

Now, let's look at the situation when an option is sold:

 

Suppose we sell a call option at 1.3 and got a premium of $500. This option's Delta is 10% (it means the value of this option will change 10% from the change in the underlying asset). When compared with a short futures position (futures selling), the price that rises 100 pips will generate a loss of 100 pips for a futures trader and ONLY 10 pips for an option seller!

If the price moves in an unfavorable direction, we can buy back the option, thus annulling our obligations. This is a way for us to limit our risks!

Despite this, classic writers stubbornly repeat over and again that it is dangerous to sell options. But they never say that statistically, 75% options expire out of the money in Chicago Mercantile Exchange. This means we can keep the premium for 75 out of 100 options sold. When buying or selling the underlying asset the likelihood of making profits is 50% at best, but when you sell an option, you have a 75% likelihood of making money. It appears we knowingly put ourselves in an advantageous position! Why is the stock exchange so generous? It's very simple! Major players hedge their risks by buying your option. They need to sell their goods at a certain price and they are prepared to pay you a premium. Sounds good, right?

Besides, options have other advantages over other financial instruments:

1.            When selling an option, you get profits at once

2.            When selling or buying an underlying asset, you get profits when the price moves up or down. When selling an option you only have to forecast where the price won't go

3.            When selling an option you get profits even if the price is within a range. This happens because of time decay (the closer the option is to expiry, the less it costs)

4.            The option has a parameter called the Delta. It shows how many pips the option price will change after the price of the underlying asset changes 1 pip.

Let's look at the example: if we buy the underlying asset and the price falls 100 pips, this is our loss. If we buy or sell an option with the Delta of 0.1 and the price changes 100 pips, the option price will change only 10 pips.

5.            Options can be used to build up option strategies with a different risk-reward ratio.

The above taken into consideration, we can draw a conclusion that option selling does not expose the trader to unlimited risks. Moreover, option selling allows making CONSISTENT and predictable profits which the Derivatives Trading Department successfully demonstrates online. You can find out further details of option trading and, in particular, option selling, at the Derivatives Trading Department within the Masterforex-V Academy.

 

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