Uncomfortable Myths About Being An Options Seller

Options can be a very complex instrument for those who are just starting out. 

It is one of the most versatile ways and have a wide range of strategies to profit from the financial markets. Among these strategies, selling options is often perceived as a risky endeavor. However, there are several uncomfortable myths surrounding being an options seller that need to be debunked.

In this article, we will address some of these myths and shed light on the realities of being an options seller.

Myth #1 - Selling Options is Extremely Risky

I do not deny that selling options entails certain level of risk.

But doesn't that apply to everything in our lives?

When we drive a car - there's a risk.

When we take a plane - there's a risk.

Heck, even when we cross the road - there's a risk.

Simply putting a blanket statement of "Option selling is risky" does not make sense to me.

Just because something is risky, it does not mean that we have to avoid it at all costs. It all boils down to proper risk management with knowledge. Here are some of the ways we can manage risk when selling options:

• Ensure sufficient options buying power after every option trade taken
• Selling vertical spreads to ensure that the loss is limited even if stock were to plunge to zero
• Position sizing so that one trade does not make-or-break your portfolio 

Myth #2 - Unlimited Risk And Limited Profit Potental

People tend to use the term "unlimited risk" so loosely. We need to properly define this. I will give you an example.

When we sell a put option at a strike price of $50 - what is the maximum risk here?

I can tell you for sure that the risk is not unlimited - and there's an actual number to it.

Here's the equation to calculate it:

Total Theoretical Risk = ($50 x 100) - Premium Collected

So, if the premium collected is $200 - the total theoretical risk would be $4,800.

Note that I emphasize on the word "theoretical".

This is because, for you to actually lose $4,800 - the stock has to fall all the way down to $0. (Think about it - what is the probability of this happening)

We need to think about term risk clearly and appreciate the context.

Risk must always be reasoned together with the probability of occurrence. Once you appreciate that, you will realise that it is not unlimited risk  as per what most people blindly define it to be.

Myth #3 - Options Sellers Have To Right All The Time

Yes, options selling have a high rate - sometimes as high as 90%.

But because we are right so often, people have this misconception that options selling must be a 100% profitable endeavor.

No - it is not.

We need to have the correct perspective on options selling and the high win rate it is associated to. A simple example is the roll of the dice.

Options selling is like making a loss every time the dice rolls 6 - but making money every time it rolls anything from 1 to 5.

When you understand the above - you realise that it becomes a game of statistics. That is to keep your losses small whenever it rolls 6 - and eventually in the long run, you will be profitable.

Myth #4 - Selling Options Requires Huge Capital

Many people have the misconception that selling options would have a huge capital requirement.

For example, if we sold a put option at a strike price of $30 - that would mean that we are promising to buy $3,000 worth of shares. Hence, requiring a capital of at least $3,000.

However, it is important to understand that we only need to buy the $3,000 worth of shares if the option is exercised. 

And the reality is that we don't need to let the option be exercised. Whenever, we sell a put option, there are three possible outcomes:

1. The option expires worthless and we collect the full premium
2. The option is exercised and we end up owning 100 shares
3. We close the option early by buying back the option

Most people forget about Option #3 - which does not require you to have $3,000 worth of capital.

What you need to have to start the selling of the put option is the option buying power - which in the above example, will require $695.85 of option buying power (i.e. much lesser than $3,000).

Some of might say, "But Gin, sometimes the stock price is just so high, that we cannot even have enough option buying power to sell the put option in the first place"

Besides selling put options - we can also sell vertical spreads which require even lesser capital (which is how I started).

For example - in the below example, you only require $419.30 of option buying power when selling a vertical spread on NKE.

In short, you do not need a huge capital to start selling options.  

Myth #5 - Selling Options Requires Constant Monitoring

For those of my readers who are like me (i.e. in the SG/MY time zone), the US stock market opens through the night where I would be sound asleep.

Because of that, people often have this misconception that we need to stay up through the night to monitor our positions.

Nothing could be further from the truth.

Personally, after I placed my trades at 930pm (or 1030pm depending on daylight savings) - I go to sleep like a baby.

The key here is to be able to (1) proper entry rules, (2) take profit rules using GTC orders and (3) trade management rules.

Once I set up the trades with the above pre-defined rules, there is actually no need to monitor the market throughout the night. So please get some sleep.

Conclusion

In conclusion, being an options seller is not as daunting or risky as it is often portrayed.

By debunking these myths, it becomes clear that options selling can be a viable and profitable strategy. With proper education, practice, and discipline, we can navigate the market successfully and extract cash flow from the stock market.