Sell Options on Futures for a Higher Probability Trading Strategy

Selling a Commodity Put Example (Crude Oil)

In the example portrayed in the displayed chart, it might have been possible to sell a September $62 crude oil put for 53 cents, or $530, at a time in which crude oil was valued near $80. The same option was worth only 17 cents ($170) just two days earlier prior to a multi-day plunge. Options that have tripled in value, as such, often have a tendency to see sharp premium erosion should the futures market stabilize. Accordingly, these types of spikes in option premium are attractive to option sellers.

commodity option selling example: crude oil short option

On the contrary, those that were already the 62 put prior to the two-day sell-off would be an unpleasant situation. This just goes to show you how important timing and volatility can be, even in a so-called passive strategy such as option selling. Simply put, making money by selling commodity options isn’t as easy as selling calls or puts and hoping for the best. Traders must be patient in order to be in a position to capitalize on an increase in volatility, as opposed to getting run over by it.

The maximum profit of this particular short option trading example, is $530 minus transaction cost. The max payout occurs if the option is held to expiration and the futures price is above the strike price of $64. However, even if the price is a little below $64, all is not lost; this short option position pays off at expiration with the price of crude anywhere above $63.47. This is because the premium collected of 53 cents, or $530, acts as a buffer to the risk of being assigned a futures contract at the strike price of $64.

Should the price of crude be trading below $64 at expiration, the risk is similar to that of being long a futures contract. The option value will fluctuate quickly and the trade faces theoretically unlimited risk.

As you can see from the chart , it is possible for this trader to be profitable whether the market goes up, down, or sideways; the only risk is in a massive price collapse (in this case below $64). If the price of crude is above $64 at expiration ($64 to infinity), the max payout is received by the option seller. In other words, the profit zone is large and likely, while the loss zone is far less likely to be seen.

Follow Carley Garner on Twitter