Have you ever wondered who sells the options that most people buy? These people are known as the option writers/sellers. Their sole objective is to collect the premium paid by the option buyer. Option writing can also be used for hedging purposes and reducing risk. An option writer has the exact opposite to gain as the option buyer. The writer has unlimited risk and a limited profit potential, which is the premium of the option minus commissions. When writing naked options your risk is unlimited, without the use of stops. This is why we recommend exiting positions once a market trades through an area you perceived as strong support or resistance. So why would anyone want to write an option? Here are a few reasons:
1) Most options expire worthless and out of the money. Therefore, the option writer is collecting the premium the option buyer paid.
2) There are three ways to win as an option writer. A market can go in the direction you thought, it can trade sideways and in a channel, or it can even go slowly against you but not through your strike price. The advantage is time decay.
3) The writer believes the futures contract will not reach a certain strike price by the expiration date of the option. This is known as naked option selling.
4) To hedge against a futures position. For example: someone who goes long cocoa at 850 can write a 900 strike price call option with about one month of time until option expiration. This allows you to collect the premium of the call option if cocoa settles below 900, based on option expiration. It also allows you to make a profit on the actual futures contract between 851 and 900. This strategy also lowers your margin on the trade and should cocoa continue lower to 800, you at least collect some premium on the option you wrote. Risk lies if cocoa continues to decline because you only collect a certain amount of premium and the futures contract has unlimited risk the lower it goes.
Hythe Securities Limited believes in writing options, but advises against doing it without the advice and expertise of a knowledgeable broker or specialist. Be strict when choosing options to write and don’t believe in writing options as your only strategy. Using the same strategy every month on a single market is bound to burn you one month, because you end up writing options when you shouldn’t. Hythe Securities Limited believes you should treat option writing just like futures trading. We believe you should stay with the major trend when writing options, with rare exceptions. Use market pullbacks to support or resistance as opportunities to enter with the trend, by writing options which best fit into your objectives.
Volatility is another important factor when determining which options to write, it’s generally better to sell over valued options then under valued options. Remember not to get caught up with only volatility, because options with high volatility could always get higher. The bottom line is, pick the general market direction to become successful over the long-term. We also believe in using stops based on futures settlements, not based on the value of the option. If a market settles above or below an area you believed it shouldn’t and the trend appears to have reversed based on the charts, it’s probably a good time to exit your positions. We can help you understand the risks and rewards involved, as well as how to react to certain situations, i.e.,: if/then trading scenarios. We can either assist your option writing style or recommend trades and strategies we believe are appropriate, using the above guidelines.
Filed under Uncategorized by on Sep 28th, 2010. 
From separate conversations and dialogues, many of you will know that I’ve harboured a view that the long end of the US Bond market is currently priced at precipitous levels and consequently that yields are not good value at all at the moment. It would naturally have been preferable had I got round to writing this update before yesterday’s FOMC statement and their begrudging ackowledgement of an improving US economy, which has since sent US Long Bond yields upwards. However, in the grand scheme, yesterda’s price action doesn’t devalue our opinion, which is that holding such instruments is only worth doing for policy error and war risk insurance cover of sorts, but they should not really be viewed as a capital gains/growth generating vehicle. Our view is that the US Long Bond Yield is prone to expand from it’s current level of c.3.4% to at least 4.4%, where it may find resistance in the form of long range averages and median rates. Our own view is that yields could approach 5% within 3 years. This slightly longer timeframe is in place to account for the current interventions to cease, whether they be QE, Twist as well as the Fed’s tacit undertaking to hold Fed Funds rates at 0.25% up to and including most of 2014. We think a large amount of the yield expansion will take place whilst these programmes are still running but mention a longer timeframe as a prudence measure.
Institutional clients that agree with this view could utilise bilateral total return swaps to express their trading view, and clients without prime brokers can use ETFs, Futures or Options to trade this view. Timing aside, we estimate that this trade, should our forecast materialise, could generate an unleveraged cash-to-cash return of 25% in a three year timeframe, and a multiple of that if leverage or derivatives are used. We fully expect there to be many bumps in the road and we expect that the cosmic events in play currently will lead to a material degree of volatility.
Filed under Meenaz Mehta by on Mar 15th, 2012.
Good Evening,
Further to our post of 23rd February, at the time of writing, you should be in profit by at least 23 Points on the S&P, 250 Points on the Dow Jones 30 Index, or somewhere over 100 points on the EuroStoxx 50 Index.
We would not dissuade you from succumbing to temptation and taking some quickie profits at this point but we do suspect that there is more downside to come before this downward move is completed.
Filed under Meenaz Mehta by on Mar 7th, 2012.
Good Afternoon, We have conducted a study comparing the CSFB Fear Index and the S&P 500 Index. The CSFB Fear Barometer measures investor sentiment by pricing a zero cost collar option strategy. The higher the level, the greater theperceived fear in the marketplace. As you will see from the chart below, the index has exceeded ~26.5 on 5 occasions since the beginning of 2010 to date, and once between 1994 and 2010 – so 5 prior occurences in all across ~18 years. The fifth is occurring now. Naturally, time will tell if this level augurs well or poorly for the equity market. However, on the previous 4 occasions, the S&P subsequently performed as below:-
March 2011 – S&P drop from 1343-1279
June 2011 – S&P drop from 1363-1271
August 2011 – S&P drop from 1345-1123
The caveats are that the drop did not occur instantly, with months elapsing before the eventual fall in some cases. Additionally, in some cases the market increased in value by a tangible amount before the eventual fall. So, for anyone trying to implement this idea in the form of a naked short, we would suggest that you buy yourself time and restrict the leverage so that you are prepared if the position goes against you initially. We do have belief in this trade but on a total return basis after an up-to-12-month holding period, much like any other investment trade. Those with long portfolios may consider buying some portfolio protection based on this.
Filed under Meenaz Mehta by on Feb 24th, 2012.
Good Afternoon, when we put out our note on Crude earlier today which flagged a break of 98.25 as leading to a potentially quick drop to 95 (and then possibly 90), we didn’t reckon on it happening 30 minutes later! Still, we now have January WTI last at 95.77, so break-out traders would have shorted Crude on the recommendation, WTI is down over US so far today and still looking pretty grim. We still have a feeling for lower WTI, and as our general and long-held view is for a strong USD (DXY), that should exacerbate the risk of further WTI/Brent weakness. On the other key instruments, most readers will know we have been looking for lower Gold prices before getting involved and we have seen sharp drops in both Gold (down US today) and Silver (down almost ), but possibly there is more to go as Central Banks and other forced sellers take profits wherever they lie. A strong USD also acts as a drag on these prices and other USD-denominated commodities. Policy error risk still runs high and so we will take a small Gold weighting at some point, but not just yet. For anyone that has followed our call on GBP/EUR, today is a good day but it’s been a steep rise in a short space of time so we would suggest trimming the positions and taking some profits. GBP/EUR last at 1.1930, up 3 big figures in just a couple of weeks.
Filed under Meenaz Mehta by on Dec 15th, 2011.