A friend told me that 80% options expire worthless. He also add; if you want to be a successful option trader, you should be selling options not buying them. I don’t know if it’s true that 80% options expire worthless. But I do know that you can make decent added income by selling options (especially selling commodity options). How decent? Two to five percent per month is my target. In this post, I will detail the step by step process of how commodity options trading can be used as your supplementary income.
This is my bread and butter trading strategy, and I love it because of its simplicity. Okay. Here’s how I do my analysis:
Keep a List of 15-20 Commodities and Track Them Closely
Create a watch list of 15 to 20 commodities and analyze them. You need to have at least some general opinion of the market.The beauty of selling options is that you don’t need to predict where the market is likely to go. You only need to predict where the market is unlikely to go. If you’re bullish on your analysis, then the market is unlikely to go lower and vice versa. It’s that simple.
Calculate the 3 month Average True Range (ATR)
Once you have a general opinion of where the market is unlikely to go, calculate the three month Average True Range (ATR). ATR is a standard indicator – included in most trading platform – that tells you the price movement of the last period. Why use three month? I’m being conservative. In case I’m wrong with my opinion on the market, I will still have some margin of safety. If you’re confident with your analysis, you can use a two months or one month ATR. Okay, I have my ATR. What do I do with this number?
Select your Option Strike Price
Your ATR is your margin of safety. The option that you’re selling should be at least one ATR away from the current price. Say for example that Crude Oil (CL) is trading at $93, and you’ve calculated the three months ATR as 7.00. If you’re bullish on CL, you should aim to sell put option at 86.00 strike price ($93 – $7). If you’re bearish on CL, you should sell call at strike price of 100 ($93 + $7).
Select your Expiration Month
Go with options that still have 30 – 45 days until expiration. To sum up; get a general opinion on the market, calculate three month ATR, sell your option one ATR away with 30 – 45 days until expiration. That’s it.
Take profit and exit the trade if your option premium is worth less than 10% from its original value. If you sold an option for $5 and now it’s only worth $0.5, take profit by buying back your option. If you’re wrong on the direction of the market (and you will eventually), cut your loss when your option have doubled in premium. For example, if you sold an option for $5 and now it’s worth $10, cut your loss and exit the trade. Don’t look back. What I have described above is what I do when I want to sell option. It has worked for me, but I can’t guarantee it will work for you. You’re welcome to use my method, but use it at your own risk.