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NEURAL OPTION POSITION |
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The Neutral Option Position is best used in markets that have extremely high premium (by selling far out-of-the-money options), and trading range markets, at any volatility level, that have little likelihood of significant movement.
A Quick Introduction
The Neutral Option Position is a trading strategy that provides the trader with many benefits over a long or short futures or options position. While most option purchases and futures trades are only successful if the market moves in the direction predicted (without the trader being "stopped out" first), a Neutral Option Position can be successful in a non-trending market or a choppy market (studies have shown that markets are in a non-trending or sideways pattern almost two-thirds of the time) or if the market moves slowly lower or higher.
In addition to allowing the trader to be successful without having to predict the exact direction of the markets, the Neutral Option Position incorporates the advantages of:
- Special Circumstances
- Price Disparity
- Option Time Decay
- Mathematics
- Probability
- Money Management
This strategy involves selling an out-of-the-money put and an out-of-the-money call containing only time value, with the expectation of collecting the entire amount of time value premium as the underlying futures contract remains within a wide a trading range.
We are, in effect, taking the other side of trades from participants on both sides of the market who are attempting to pick the direction of the underlying futures contract. Some feel that the market is going up, while others believe that the markets will head lower. The traders who feel that the market is going up purchase calls, while those negative on the market purchase puts.
We, in effect, are staying evenly balanced in our positions; however, we have an advantage in doing so. With our Neutral Option Position we can profit on both sides of the market (if the market stays within our predicted or adjusted trading range).
For example, with treasury bonds trading near 113, we can take the view that the market is going to remain within the range between 110 and 120 and sell the 110 put and the 120 call.
These options are sold to other traders who were acting on their prediction of market direction that the market was going below 100 (puts) or above 120 (calls). We were making no predictions other than that it would remain in a wide trading range.
Every day, both options sold lose some of their time value. Further, adjustment techniques are available, allowing us to "rebalance" this position when necessary. Remember, there is always unlimited risk of loss when an option is sold, so risk management is always important.
The benefits of this position include:
- Not having to predict market direction.
- Being able to profit from both sides of the transaction - both from the buyers of puts and buyers of calls.
- Being able to take advantage of the "overvalued" time value of out-of-the-money options because, while the amount of option premium changes from time to time, traders continue to buy options, thinking they can "beat the market."
- We can increase the number of positions based on favorable market conditions (high option premium), and we have forty different commodities from which to choose for the sale of options.
- Finally, we have the ability to both adjust our positions and increase our position size. It has been mathematically proven that with sufficient capital, the probability of making a profit becomes greater.
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© 2002-2008 Opportunities In Options - All Rights Reserved |
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Although this information is believed to be correct and from reliable sources, no guarantees are being made to its accuracy. Past performance is not indicative of future results. All trading involves a risk of loss.
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