Option Trading Thinking Outside The Box
Below is a MRR and PLR article in category Finance -> subcategory Other.
Option Trading: Thinking Outside the Box
Summary
Imagine buying an option with five months until expiration and selling an option with two months remaining for the same price. It sounds like a win-win, doesn't it? While it's not that simple, there's a valuable lesson in options spreads worth exploring.Understanding Options Spreads
Options spreads allow us to buy a spread with significant time value and sell one with less time value for almost the same price. This insight changed how I view options trading.By analyzing option prices across different strike prices and months, I discovered which options are more expensive per day. Initially, short-term options lose time value quickly. In these scenarios, at-the-money options cost much more than out-of-the-money options. However, in longer terms, the opposite is true.
Consider the S&P market:
- A 6-day at-the-money option costs 12 points, while an out-of-the-money option costs 2 points.
- A 70-day at-the-money option costs 43 points, but an out-of-the-money option costs 29 points.
There's more than ten times the time left, yet the 70-day at-the-money option is only four times the price of the 6-day option. Meanwhile, the 70-day out-of-the-money option costs nearly 15 times as much as its 6-day counterpart.
Strategy in Action
Our strategy involves buying cheaper per-day options and selling more expensive ones. We sell the 6-day at-the-money and buy the 70-day at-the-money, while simultaneously selling out-of-the-money options. This creates a spread for a minimal cost, leveraging significant time value.After the 6-day options expire, we can enter the next month and collect more premium, maintaining the 70-day spread.
Lessons from Successful Traders
The famous saying, "What goes up, must come down," applies in reverse to the commodity markets. Legendary traders like Warren Buffet have capitalized on this by understanding a commodity's intrinsic value and purchasing when prices dip.Authors like those of "You Can't Lose Trading Commodities" advocate for buying low and waiting for an upswing. Of course, a substantial bankroll is essential for this approach, as markets can be unpredictable.
Applying the Strategy to Futures
I’ve successfully applied this strategy in the Soy Complex with futures. Mimicking a crush spread, I increased contracts as the market dipped, requiring only a minor rebound for profitability. It's a refined version of a blackjack betting system, which systematically increases bets to recover losses.Modified Strategies and Cautions
While doubling down on trades isn’t advised, identifying low-market entry points for strategic trades can be effective. Spreads, with their tighter high-to-low ranges, offer promising opportunities.Primarily used for long positions, this strategy involves identifying undervalued markets for quicker and less costly trades. Options spreads, particularly those minimizing Theta decay, allow for profit even in stagnant markets.
In essence, by thoughtfully using options and spreads, one can leverage time value and strategic positioning to capitalize on market movements efficiently.
You can find the original non-AI version of this article here: Option Trading Thinking Outside The Box .
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