Option Selling with Implied Volatility in Options

Higher premiums collected not only increase a futures market trader’s profit potential but it also increases the room for error. The money collected for a short option can be viewed as "cushion" in that it defines the amount in which the trader can be wrong and still make money by shifting the reverse break even further from the market. The RBE of a short put is calculated as follows:

RBE = Put Strike Price - Premium Collected + Commissions and Fees

As you can see, the more money that the option seller collects, the deeper-in-the-money the option can be at expiration without resulting in a loss to the trader. 

According to the hypothetical data available to us, in July of 2002 with the September futures e-mini S&P price near 780, it may have been possible to sell the August S&P 500 futures 680 put for $4.3 in premium which is equivalent to $215 before commissions and fees (each point in the e-mini S&P is worth $50). If this was the case, a trader could have collected a little over $200 U.S. dollars for an option that was, at the time, approximately 100 points or nearly 13% out-of-the-money.

$215 per contract before transaction costs might not sound like a lot of money, but considering the margin on the trade (required deposit in a trading account) was under $1,000 most traders could have sold them in reasonable multiples. For instance, selling 5 of the August 680 puts might have brought in a little over $1,000 in premium for a margin requirement of less than $5,000. Those that like to calculate return on margin, it would have been roughly 20% had the option seller held the short futures options to expiration a mere four weeks down the road.


Follow Carley Garner on Twitter