Friday, July 25, 2008

Selling long vs. short term options

It is often a wise idea to sell short term options in the stock market. There are many reasons for this.

Short term gives you more control. No one knows what will happen to a stock 3 months down the road. It is easier to predict which way the stock will be heading in just a few weeks as opposed to a few months.

Selling short term options also allow you to capture the more premium over a longer time frame. For example the stock XYZ has a front month $30 put selling for $2 it also has a $30 put 3 months out selling for $4. At first glance it seems like you would get more money selling the $4 option 3 months out but that is not necessarily true.

If you sold the front month option for $2 and it expired at the end of the month you could sell it again next month or a higher option if the stock moved up. You could sell 3 puts each for $2 totaling $6 before the $4 put would have expired, if you were right.

The longer term option seller does however have some good advantages over the short term seller. First of all you can sell farther out of the money. Because the future is uncertain the farther out you go the higher the options will be selling for. A stock probably will not go from $50 to $70 in two weeks but it might in two months.

The other advantage long term sellers will have is that strong stocks go up on average. If you find a strong stock there is a good chance that over a longer time period the stock could head up which may not be true in a shorter term period.

Every trade has their own opinion on which method is better, which is what makes the stock market what it is.

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