The Two Common Trading Styles for Option Writing

8 min read

When it comes to option writing, there are mainly two types of trading styles:

1. Longer Duration Option Selling – where positions are carried for longer duration lasting anywhere between a few days to months and even years in some instances. Note that it doesn’t relate to selling longer duration option but selling option with an intention of carrying the position longer than intraday.
2. Intraday Option Selling – where positions are opened and squared-off towards the end of the session.
   While a lot has been said and written about longer duration option selling strategies, I mean pick up any book or blog post on option trading strategies and you would invariably find detailed coverage of longer duration option trading strategies. This is simply because of their unique characteristics such as theta decay, fixed lifetime and so on.

Snail to Snake

The world had pretty much got accustomed to the fact that option selling is a longer duration game until the traders started using shorter duration options for intraday profits. This was partly made possible with the introduction of weekly options that converted the slow-moving option trading game like a test cricket into a T20 style of trading (you will only get the analogy if you are into the game of cricket but if you are not then refer the heading of this paragraph). Since not much has been covered on shorter duration option selling, I am dedicating this post to intraday option selling and cover some ways intraday sellers can make money and also manage their risks. I am not covering expiration day trade in this post even though those trades too can also be classified into traday trading category. To read more on expiration day trading and its pitfalls, read my post, “the growing trend in option selling – expiration day trading”.

The Key Difference Between Longer Duration and Intraday Option Selling

Full time traders usually resort to both types of option selling styles whereas part- time traders tend to prefer longer duration option selling only. Every profitable option trader starts off by selling options for longer duration and then slowly gains the confidence to trade intraday which as you would find out is an altogether different ball game. In my opinion, selling longer duration options is the only way a beginner should kick start his trading journey. However, there is no set path and ultimate wisdom in option selling can be achieved by anyone regardless of how they started.

The strategy usually deployed by overnight/longer duration option seller involves selling into the strength and buying into the weakness. In other words, they sell puts when markets go down and sell calls when it goes up. Pretty much akin to selling insurance to fearful investors who rush to buy puts to protect themselves from further downside or selling calls to greedy investors who rush to buy calls and benefit from further up move. Somewhere in the middle of these two option buyer groups sits a calm market maker who simply goes about his regular business of selling assurance (put) to the fearful and hope (call) to the greedy.

This also happens to be exactly opposite of what option selling for day traders looks like. They sell calls when markets go down and puts when markets go up. By doing so, they largely bet on premium decay due to price action. But sometimes volatility drop and/or theta decay also contributes to intraday decline in premiums. These traders prefer to square-off their positions by the end of the session with profits to the tune of the move made by the underlying. This strategy normally works best during trending days. But even on a dull day with the underlying hardly making any moves, the theta decay on shorter duration option spells out decent profits. Note that the key term here is shorter duration options and that’s why weekly options are so popular especially amongst retail or intra-day traders. One may not see enough premium decay on options expiring in months, but weekly option degrades fast enough to keep intra-day option writers interested in sticking to the screen all day.

The Intraday Strategies and their Adjustments!

Selling Intra-Day Straddles

A strategy some seasoned intra-day option sellers deploy is starting off the day’s session by selling naked or hedged straddles (Iron fly) and let the premium decay help them earn their dough for the day. It is imperative to choose the underlying witnessing its IV (implied volatility) trending downards. Also, right after the beginning of the session; one must wait for the underlying asset to settle down in the price and then choose the appropriate strike to put the straddle on. And of course, they avoid putting on the straddle if you are anticipating the markets in general to stay in trending mode for the day. If the underlying starts trending in one direction after putting on the trade, they immediately square-off loss making position and double down on the ones in profit. Theoretically speaking, one may argue that a good option seller never comes back home empty handed. This may not be an entirely illogical argument to make but I would refrain from offering false hope to my readers and would prefer to reinforce the hard reality that losses are an integral part of the game. Yet, I must also add that one can achieve consistent profitability even in intraday option selling by grinding long enough, paying their tuition fee to the market by means of ample losses and mastering the trading nuances of options.

Selling Intra-Day Strangles

Like selling intraday straddles (or Iron fly), it is also not uncommon for traders to sell strangles or Iron Condors in intraday. While on the surface, Iron condors may seem to be a strategy more suitable for risk averse traders yet, I beg to differ. On a calm day, both straddle and strangles may yield good profits but when compared with each other, straddles tend to yield higher returns on such day. This is because all else being equal, ATM options decay in value much rapidly than OTM options.

There is another reason as well to prefer straddles over strangles and that is about the unit of risk one takes vis-à-vis potential returns. Sometimes, the markets tend to move so violently that it becomes harder to exit the challenged side trade without booking substantial losses. So much so that even doubling down on the profitable side may not suffice to recoup the losses on the lost side. This is because the premium decays so rapidly on the winning side that even adding on from those levels sometimes fall short in indemnifying you from the intraday loss you already booked in the beginning. Yes, you can keep booking profits and roll up/down your winning trade to chase the underlying, but this strategy too adds on to risk during abrupt direction reversal. Despite that I would suggest chasing the underlying under such circumstance albeit with caution to recoup losses in intraday only if there is enough time left in the day to do so. If more than 2/3rd of the session has already gone by, perhaps chasing the underlying too may no yield sufficient profits without taking additional risk for limited returns.

Rescued by Future

One may also consider hedging the loss-making side by taking position in futures. I do it quite often and one must only do so if the movement in underlying is too furious that your risk on reversal of futures position seems very low. For instance, if you sold a two lot strangle and your sold calls get into trouble due to constant up move of the underlying then you may consider buying two lots of futures contract on the underlying asset as your first step to manage the risk. As soon as the futures position yield MTM profits equivalent to the loss in sold calls, consider squaring off both the positions. At this stage, you may or may not have added on to your winning sold put position. Nonetheless, whatever your puts had fetched would only add to your profits as your losses in sold calls have already been nullified by the bought futures.

Note that it is imperative that you have enough buying power to take the position in future for minimizing your risk. If under any circumstances, you failed to take the futures position due to low buying power then close out your loss making trade immediately in the name of discipline instead of staying in the trade in the hope of reversal.

In a Nutshell

Intraday option selling can prove to be a very rewarding endeavor as long as one is confident and experienced enough in handling loss making trades and predicting the moves on the underlying. Part time traders and beginners must avoid selling options from intraday point of view as it requires full time attention and whole day screen time to escape bigger losses. Lastly, I would also recommend the option writers to only consider intraday option trading as means to generate (almost) daily income rather than making it the centerpiece of their trading. They must not forget that their real advantage and gains lie in writing the longer duration options. While there is no thumb rule, yet I prefer not to allocate more than 25% of my capital on intraday options trading. At times, it may reach close to 100% during days when I don’t see any opportunities elsewhere. Usually this happens when markets appear too calm on the surface yet there brews a storm underneath e.g. deteriorating breadth where most of the stocks end in red on a consistent basis yet the headline index keeps going up due to larger movement in one of two heavy weight stocks. These are the times when I prefer to sit on cash i.e. trade intraday and close out the positions to get back into cash by the end of the day while patiently waiting for the movement on either side to sell options with longer duration horizon.

In the end, whichever way you prefer to go about your option writing, know that there is always more than one way of making money in options trading. There is no dearth of options for option writers, and you can sell options to earn on a daily, weekly, monthly, and even annual basis. What a wonderful invention these option instruments are..!

Blue skies,

Sanjeev Kaushik