Selling options has indeed many advantages over buying options – but as with all things in life – some will do it better than others.
To talk about trading options without acknowledging the facts, is, to say the least, foolish.
Some persist to talk about valuation models, volatility skews, etc, etc, and much more of the academic hype that is fine for teaching textbook trading, but others talk of trading options with respect to how the game really works.
I know who I want to listen to, but then again, it is really common sense, a thing that many so called experts seem to be lacking around here.
When you have a credit spread on and Index Option, you must manage it, the same as any trade that you have in any market.
A credit spread is created by selling an option, and purchasing another less expensive option.
When writing a credit spread, the writer is "credited" the difference between the premium collected from writing the option, less the cost of the option purchased. The option credit spread risk is limited to the difference between the strike prices of the option written and purchased, plus commissions and fees. Any loss would be further reduced by the amount of the credit received. While the option credit spread clearly offers the advantage of defined risk, the writer must sacrifice some of his potential profit in exchange for acquiring a limit to the potential loss.
If a put spread is written on the S&P 500, and the spread is not closed out prior to expiration, the strategy will be profitable if the S&P 500 futures price is above the strike price of the put written when the spread expires. If the futures price of the index is below the strike price of the put when the put that was written expires, the strategy may produce a loss. The loss will be limited to the amount of the difference between the strike prices of the two options in the spread. For example, if a put with a strike price of 900 is written, and a put with a price of 875 is purchased, the maximum loss on the spread is 25 points, minus the original credit on the spread. If this spread were originally put on for a credit of 5 points, the maximum possible loss is 25 x $250 = $6,250 minus the original $1,250 credit, or $5,000 plus commissions and fees.
Now, in reality, would a trader let this loss develop without hedging – well, if he is any good, he would not, but if he is a fool, he certainly would. :idea:
