5 Quick Tips to Become A Profitable Option Seller

Many people perceive options trading as a complex and risky venture, but since you reading this article, you are different. You are someone who is willing to understand the intricacies of this financial instrument.

Contrary to common misconceptions, options serve as a vehicle to gain exposure to stock movements while providing a discernible advantage in the market.

Drawing from my personal experiences and the lessons learned through painful battles in the options market, I share five crucial tips for those embarking on the journey of options trading.

Tip #1 - If You Fail To Plan, You Plan To Fail

Crafting a comprehensive trading plan is paramount. This entails clarity on three fundamental aspects:

• Determining Entry Points: Identifying the opportune moment to enter a trade is a cornerstone of any successful trading strategy. To achieve this, one must establish clear criteria. These criteria include a substantial stock trading volume exceeding 3 million, ensuring market liquidity. Additionally, a narrow options bid-ask spread below $1 is crucial to ensure that you can easily close your option trades. Finally, the inclusion of trend identification and appropriate stochastic levels further refines entry decisions, specifying optimal conditions for both bullish and bearish trades.
  
  
• Optimizing Profit-Taking Strategies: A strategic approach to profit-taking is paramount for sustainable success. The trading plan advocates for a disciplined profit-taking strategy – capturing gains when the option premium reaches a 50% increase. This tactical move not only locks in profits but also contributes significantly to an enhanced overall win rate. Think about it - which is easier? Waiting for a 50% profit or a 100% profit? The idea is this, take profits and simply recycle the capital to next high probability trade. For example, there are occasions where I easily hit 50% premium profit within a span of 4 trading days. If I were to wait for the full premium collection, I would have to hold on to the trade for another 40+ days or so - for the time decay to churn out the remaining profit.
  
  This is why taking profit at 50% levels is a more efficient use of capital. Personally, I do not wait for a 100% premium, as a single black swan event can lead to a draw down of your capital - making it harder to compound your money.
  
  
• Implementing Loss Mitigation Measures: In the volatile realm of financial markets, acknowledging when to cut losses is as crucial as identifying profitable opportunities. The trading plan advocates for the implementation of stringent rules for cutting losses. These rules come into play when the original thesis is invalidated, a scenario often signaled by the breach of crucial support or resistance levels.
  
  An additional rule of thumb is to cut losses when the option price reaches 200% of the original premium, acting as a safeguard against substantial downturns.

Tip #2 - Be Hyperfocus on Higher Probability Trades

The appeal of engaging in options selling lies in the unique ability to finely tune and define your win rate, a strategic advantage that should not be underestimated.

For those who have undergone the free Options Cheatsheet training, you're familiar with the two key determinants of your overall win rate in option trades: (i) Statistical Win Rate and (ii) Mechanical Win Rate. Your role as an options seller is to adeptly maximize both these win rates for a successful trading trajectory.

In understanding the Statistical Win Rate, the process is fairly straightforward. It revolves around examining the Delta of the option trade. As evident in the illustration, the smaller the Delta, the higher the probability of securing a profit. However, a critical consideration arises – opting for the lowest Delta results in a diminished premium collection. Hence, the delicate balance between the probability of profit and the premium collected becomes paramount in strategic decision-making.

You might ponder, "Why not sell options with the lowest possible Delta then?" The answer lies in the need for equilibrium, as an excessively low Delta sacrifices premium, prompting the importance of a approach to strike the right balance.

A guideline is this - If selling vertical spreads, aim for a delta of less than 0.25. For single options, aim for a delta of 0.20.

Beyond the statistical win rate, various factors can influence and elevate your win rate. Incorporating technical analysis is critical to enhancing what I refer to as the Mechanical Win Rate. Personally, I utilize trend analysis, stochastics, and support/resistance levels to strategically position entries, thereby gaining a mechanical edge in the market.

For those intrigued by the prospect of enhancing their mechanical win rate, I invite you to explore the Options Cheatsheet, where a free video training is available. It delves deeper into the nuances of increasing your mechanical win rate, providing valuable insights beyond the scope of this article.

Tip #3 - Let the Trade Play Out

Consider the process of selling options as akin to planting a tree. Once you've planted the seed in favorable conditions, symbolizing a high win rate, it becomes imperative to trust the unfolding process. Much like waiting for a tree to grow and flourish, successful options trading demands patience. Despite occasional unpredictable market fluctuations, akin to unexpected weather changes affecting a growing tree, succumbing to panic during these moments could impede the overall growth and potential success of your planted options.

Novice option sellers, lacking experience, may exhibit a tendency to prematurely cut their losses at the slightest sign of market sway. Weeks later, reflecting on the stock chart, they might realize that had they refrained from hastily cutting losses, they could have capitalized on potential profits.

A crucial golden rule in understanding options is recognizing that as long as the current share price does not touch your strike price, you remain in a winning position. Acknowledging that stock prices can move in three directions – upwards, downwards, and sideways – is fundamental.

Selling options unveils a unique aspect wherein profits can be made in two directions. If you sell a put option, gains materialize when the share price rises or even moves sideways. Conversely, selling a call option yields profits when the share price falls or remains stagnant.

Considering the conditions established by previous mechanical and statistical rules, it becomes evident that patience is key. Waiting for the trade to naturally unfold eliminates the need to cut losses prematurely. The realization that option sellers can profit in diverse market scenarios reinforces the importance of adhering to the meticulously crafted game plan.

Tip #4 - Be Careful of Earnings Season

Earnings season introduces a heightened level of unpredictability in stock prices, making it a crucial period for option traders to exercise caution.

During this phase, the financial landscape becomes particularly erratic, with stock prices exhibiting unforeseen fluctuations. If you are engaged in a directional trade, be it bullish or bearish, a prudent approach is to avoid holding the option trade through the earnings period, especially when selling options.

Consider the scenario of a stock experiencing a substantial decline of over 12% during earnings, as illustrated in the example charts provided. Now, envision holding a bullish vertical spread position during this period – the impact could be substantial, leading to undesirable outcomes.

This serves as a stark reminder of the inherent risks associated with holding option positions over earnings, particularly for sellers. The potential for adverse price movements, as exemplified by the >12% decline, underscores the necessity of adopting a cautious stance.

In alignment with this principle, I, as a seasoned options trader, refrain from holding option positions over earnings. This precautionary measure aims to shield against unforeseen market reactions and adverse developments that can significantly impact the outcome of option trades.

For some of you, you might feel tempted to "take that bet" - thinking that the share price may move in your favor. Personally, I refuse to take that risk. However, if you would like to take such a bet, I suggest that you only take such bets with vertical spreads and not naked options.

In essence, Tip #4 emphasizes the importance of recognizing the unique challenges posed by earnings season and advocates for a vigilant approach, steering clear of holding option positions during this inherently unpredictable period.

Tip #5 - Live to Trade Another Day

For those who have been followers of Passive Seeds, I reiterate a crucial principle that cannot be emphasized enough – a principle particularly vital for those engaged in options selling.

The appeal of option selling lies in its remarkable high win rate, a fact I've experienced firsthand with win streaks reaching as high as 12 trades consecutively. However, as any seasoned trader knows, success can be a double-edged sword, and this is where the cautionary tale begins.

The temptation of overindulging in success often arises, as the lure of continuous winning streaks prompts the inner voice to suggest, "We are having such a high win rate, why not trade more in the next trade?" This is the pivotal moment when greed can swiftly take control, leading to potentially disastrous consequences.

To counteract this insidious influence, a steadfast commitment to strict portfolio sizing becomes the trader's armor. In my personal practice, I adhere to a stringent limit of a 10% margin requirement in every trade – an upper bound that I never exceed. This disciplined approach serves as a protective shield, allowing me to sustain a consistent trading rhythm while leveraging the statistical odds in my favor.

The rationale behind this strategy is clear: by imposing a cap on risk per trade, I mitigate the worst case scenario where a single unfavorable trade could obliterate the entire portfolio. Having witnessed such unfortunate outcomes in the past, I am acutely aware of the importance of safeguarding against the pitfalls of excessive risk.

In summary, the essence of sustained success in option selling lies in resisting the call of greed and adhering to disciplined portfolio management. By setting strict risk limits, traders can not only weather the fluctuations inherent in the market but also position themselves for the longevity and resilience required in the dynamic landscape of options trading.

My Final Thoughts

From my many years of option selling - protecting your capital has been the most critical one.

Reflecting on the market downturn of 2018, I witnessed the power of greed that eroded a significant portion of a close friend's portfolio. This serves as a stark reminder of the importance of preserving capital in the face of market volatility and unexpected downturns.

It's crucial to internalize this lesson: while option selling can be immensely lucrative, it is imperative to avoid overleveraging your account and succumbing to the allure of "all or nothing" trades. The allure of substantial gains may be enticing, but the risks associated with overexposing your capital are substantial. The potential consequence of such a gamble is stark – ending up with nothing.

In essence, the sage advice is to approach option selling with a disciplined and risk-aware mindset, recognizing that prudent capital protection is the cornerstone of sustained success in the dynamic realm of financial markets.

I share these thoughts to help my readers be careful and smart when dealing with the ups and downs of the financial markets. I want them to learn from the experiences I've shared so they can avoid making unnecessary mistakes and facing setbacks in their option selling ventures.