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Option Selling
Option Selling
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Abstract—In this paper, option selling strategy is discussed Option buyer (holder) can exercise the prepaid option to
which is different from traditional equity and commodity buy or sell some financial product within an agreed time
trading strategies. Option selling strategies can achieve various interval but is not obliged to do so. On the other hand, option
non-linear Profit & Loss (P&L) graphs instead of traditional seller (writer) is obliged to agree to either of the buyer’s
linear P&L graph. Option sellers make money through taking decisions.
advantage of time value of option. Option sellers collect
premium as time elapses. Selling straddle is proposed in this In addition to non-linear payoffs, there are four
research. The strategy is back-tested using Hang Seng Index key advantages (in no particular order) that options may
(HSI) Option data. The return of the proposed strategy is give an investor: they may provide increased cost
compared with HSI and its performance greatly outperforms efficiency; they may be less risky than equities; they have
HSI. The great profit generating ability of option selling the potential to deliver higher percentage returns; and they
strategy is verified in this paper.
offer a number of strategic alternatives.
Keywords-component; Option; trading strategy; option Options have been around for more than 30 years, but
selling; straddle options are just now starting to get the attention they deserve.
Many investors have avoided options, believing them to be
sophisticated and, therefore, too difficult to understand.
I. INTRODUCTION Many more have had bad initial experiences with options
For more than a century, stock and commodities traders because neither they nor their brokers were properly trained
have fueled price rises and falls at exchanges across the in how to use them. The improper use of options, like that of
globe. Fortunes have been made and lost — some over the any powerful tool, can lead to major problems. Finally,
course of a lifetime, others over the course of an hour. The words like "risky" or "dangerous" have been incorrectly
rules of the game are simple. Investors either buy low and attached to options by the financial media and certain
sell high or sell high and buy low. popular figures in the market.
Investors and speculators try to profit today the same way In this research, the focus will be option selling
their ancestors did many generations ago. Whether they are strategies. Although option selling strategies are associated
trading stocks or commodities, or currency, the basic concept with limited profit and unlimited risk, there is strong
of investing has not changed — the bulls buy and hope the evidence to support the notion that option sellers have more
market rises, the bears sell and hope it falls. chances to profit than option buyers.
Traditional assets (e.g. stock and commodities) have Futures magazine published a study in [1] regarding the
linear payoffs, i.e. the profits as well as losses for the buyers proportion of options that expires as worthless. The study
and sellers are unlimited. Options have non-linear payoffs. tracked options in five major futures contracts: the Standard
Theoretically, option buyers take limited risk and gain & Poor’s (S&P) 500, the Nasdaq 100, Eurodollars, Japanese
unlimited profit, while option sellers have limited profit and yen, and live cattle. It was conducted over a three-year
unlimited risk. Options allow investors to create unique period from 1997 to 1999. The research came to three major
strategies to take advantage of different characteristics of the conclusions.
market — like volatility and time decay. 1) On average, three of every four options held to
Options are basically contracts between two parties, the expiration expire worthless (the exact percentage was
buyer and the seller, giving the former the right to purchase 76.5%).
or sell some underlying asset, with specification of price and 2) The share of puts and calls in options that expire
validity period. The specified price is called the strike price
worthless is influenced by the primary trend of the
and the validity period is also called the expiry date. Options
are called derivatives for two reasons: the first is that option underlying market.
trading is derived from stock and futures trading; and the 3) Option sellers still come out ahead even when they
other is that option price always depends on (derives from) are going against the trend.
the value of the underlying asset, be it stock, index or some
commodity.
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Figure 2. P&L Graph of Short Straddle Position at Expiry.
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management into consideration. These two factors will be
included in future research.
REFERENCES
[1] J. F. Summa. Option Sellers vs Buyers: who wins? Futures, 2003,
32(4), pp. 52–55.
[2] J. Cordier and M. Gross. Option Selling with Limited Risk. Futures,
2005, 34(9), pp. 52–68
[3] T. Zurick. Setting the Stage for Option Selling. Futures, 2005, 34(1),
Figure 3. Return Comparison from 2006 to 2010 pp. 52–54.
[4] T. Zurick. Option Selling: Getting Defensive. Futures, 2005, 34(4),
As can be observed in Table 1, yearly average return pp. 42–45.
(88.8%) of straddle strategy greatly outperforms HSI [5] T. Zurick. Option Selling: Getting Defensive. Futures, 2005, 34(5),
pp. 48–50.
(16.5%) during the period of 2006-2010. In Table 2, we can
[6] D. P. Collins. Are option writers due for a fall? Futures, 2006, 35(7),
see that straddle is also much better than HSI in terms of pp. 62–66.
yearly compound return and average monthly return. The
[7] T. Elenbaas and D. Tsou. Risk Management for Option Writers,
volatility of monthly return of straddle is worse than HSI in
terms of volatility. However, its sharp ratio (1.41) is much Futures, 2006, 35(12), pp. 22–24.
better than HSI (0.46) due to its high return. [8] L. Lowell. Three dimensional trading. Futures, 2007, 36(9), 42–43.
From above comparisons, we find that option selling
strategies have great profit generating ability. The [9] J. Cordier and M. Gross. Collecting premium with help from the Fed.
performance has been verified in this research. It can be used Futures, 2008, 37(7), pp. 48–50.
as an new investment asset in the portfolio. Although the
[10] J. Cordier and M. Gross. Examination of long-term bond Ishare
back-testing results show that straddle greatly outperforms option selling strategies. Journal of Futures Markets, 2010, 30(5), pp.
HSI, we did not take risk management and capital 465–489.
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