TSC Options Forum: Trading In the Dark

Today's Options Forum makeup question was submitted last Thursday just before the lights went out:

Steve, I was sort of surprised to read this in last week's column:

"It seems the big bet is that nothing happens over the next two weeks and traders just sit on their hands waiting. Currently, the prospects of owning a decaying option or exposing yourself to unlimited risk are equally unappealing."

Aren't low volatility and restricted trading range considered ideal for certain strategies (short strangles, selling an out-of-the-money call and put)? Or do the pros regard such methods just for amateurs?

Thanks,

-- RHR

While the blackout ultimately amounted to little more than another day of time decay -- volume was low, the volatility index barely budged and the indices ended fractionally higher -- I'm sure many option traders saw a spike in their blood pressure and lost a few pounds sweating out Friday's opening. Remember, the first reaction was to send S&P 500 futures down 20 points, or more than 2%.

Strategies such as short strangles, straddles or naked option selling are most certainly used by professionals or full-time traders, but they watch the position and typically look to buy options when volatility is low and sell when it's high. But since they carry unlimited risk, most part-time or longer-term individual investors (I don't like the term "amateur," since it connotes doing something for no pay or profit and that ain't the game we play here) should be careful about establishing net-short option positions.

My caution regarding premium selling as an ongoing strategy (you may collect nine times out of 10, but that loss is usually a doozy and can put you out of business) comes from two places: personal experience and my preference to err on the side of caution when dispensing advice to a broad audience.

This doesn't mean that selling premium is verboten; in fact, I'm a huge proponent of letting time work in your favor. It's one of the few immutable and predictable pieces that can be plugged into an options' pricing formula; no matter what else happens, time will pass. I've recommended selling premium in all forms, from naked calls and puts to calendar spreads; even a short strangle has its time and place.