Mini Case Study On Why Premium Selling in Options Is Profitable

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Sell options: In this tutorial, we're going to go over just the two quick trades that we had today on Wednesday, August 26th. We had one new opening trade today and then one closing trade. We weren't that active today because things were going our way. The market popped up higher, and implied volatility for the most was lower a lot of the things we had.

The position is on, so that helped us out, we were up well over $1000 today, which helped out and getting things back from the volatility expansion that we had in the market drop. Today, we also added another position to TLT. TLT has been quick of a mover. 

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It's actually moved a lot faster than I thought it would move kind of after this rally up higher, so now we're adding another iron condor, iron butterfly type position where we are selling options right at the money at 123 and then going out $10 on either end and buying protection, so down to the 113 puts an ounce to 133 calls.

For doing this, we are taking a massive credit of about $510, which honestly is a huge credit given the risk. Now you see where TLT is at about one 22 ½, or about 122 today's where ended up closing out, but our break-even point from the 123 strikes brings us out to about 128 on the top side and at about 118 on the bottom side.

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We have a massive profit window here from which to make money as long as TLT trade inside this range; we don't care where it happens, and implied volatility drops. We're stacking this trade on top of our existing trade, which was centered a little bit higher than the market and so that gives us an even broader range overall together.

I like this trade in TLT just because of the premium that is commanding right now, so you can see both positions that we have are in October. You can see that first position that we have was centered right around 128, so much higher, and then now we're starting to center our positions a little bit lower.

This is the beauty of stacking trades, not throwing all of the trades in at one time, but spreading them out over time is that we now have the ability to start rolling down and coming closer to where the market is, and so if the market goes lower, will probably add one more position to this kind of TLT trade that we've made here.

The markets are extremely liquid, the big-ass spreads when the markets are trading is pretty tight, so we wanted to be involved in this area. As far as closing trade, we were able to close out just one of our vertical spreads in XLE today for a nice little profit.

This is only about a two-day profit covenant, so again we are trying to keep some of these short, bearish positions specifically on our portfolio to take advantage of the fact that the market might move down or implied volatility might drop. Give us a little bit of a hedge in the meantime, while kind of our core positions, or strangles and straddles have time to work.

This XLE credit spread we bought back for 10 said debit, so we made a nice little $100 round profit on it. Again, honestly, this was nothing more than just mostly the stock moving lower, although it did move almost 3 ½% higher today.

The real money was made on the drop in implied volatility, and this is, again, this is why we have to be sellers a premium here, because even though the market moved up 3 ½% today for XLE, we made money on this trade because implied volatility went from hundred to 71. That's where the real money was made is right here on this drop in implied volatility, not necessarily on the price move.

The volatility move had a bigger impact on the option pricing than anything else. That's really just kind of a key case study, a little mini case study in why selling premium is so profitable, even when the market makes kind of these crazy moves. Hopefully, we can maybe reload this position if XLE moves a little bit higher.

We're long on a couple of little oil things, so a move higher in oil is generally going to help us right now, we might look to go ahead and kind of re-execute the same strategy may be just at a higher price in XLE over the coming weeks. That's all we have today.

If you have any questions or comments, please leave me a note right here on the Trading Large page for members, and until next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.