Option Selling: What Duration Is Optimal For Our System?

Introduction

Selling options requires the 3-pronged skill set of strike price selection (10-14 delta in our case), selecting good underlyings (low-volatility stocks, based on thoroughly analyzing the technical and fundamental conditions) and duration. Duration is essential as we have to determine what time to expiration is needed to realize a nice profit, while looking for options that are not sensitive to gamma. In other words, is there an optimal duration which allows for steadily growing profits with the least amount of volatility?

We prefer two-month options over one-month options as we then collect at least 50% of our initial credit, while maintaining a high probability of profit and a wide win area (width between the call and put strike). After being 30 days in the trade, we want to roll out and reset to a new two-month duration. Why 30 days? Because that's the point where holding onto an 11-delta strangle doesn't pay for us anymore. Who wants to allocate a sizable amount of money (i.e. margin) to an investment which isn't going to reward you as generously as it did before? Just roll out to a new option series and get more bang for buck instead.

Also, we want to sell premium on stocks that see elevated implied volatility. Over the course of the trade, short vega starts to decrease which means that if we see a collapse in IV, the shorter-term options will benefit little from that event. Likewise, if the implied volatility rank remains elevated at 30 DTE, our volatility edge is much smaller than it was at the very beginning. Also, the opposite is true: higher IV will impact longer-term options more than the shorter-term series. During the lifecycle of the trade, theta (time decay) becomes more important than the risk of a surging IV, as shown below. For example, if you collect $100 in positive daily theta, you're short Vega worth $600. At 30 DTE, your positive theta is $70, while your short Vega amounts to $200. So if IV goes up 1% at 60 DTE, you are very likely to lose $500; at 30 DTE, that figure stands at $130.

1 2
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience. Users' ratings are only visible to themselves.

Comments

Leave a comment to automatically be entered into our contest to win a free Echo Show.