Hi folks,
I see that a guide to sell options is requested and i’m writing one for you guys.
We are gonna need some things:
- A stock to buy/sell
- An option Broker
- The Fantastic tool you guys have on ItalianDividends (:))
The idea here is simple. If we don’t possess the stock we would like to own, we can sell puts in order to 1) collect the premium and 2) buy the stock at a lower price than the spot one. If we possess the stock, we can sell calls in order to 1) collect the premium and 2) sell the stock we possess at a higher price than spot price.
Drawbacks? A few. If we sell a put option and the stock keeps falling we are going to loose potentially without any limit until the stock goes to zero. On the other side, if we sell a call, we can’t gain from the appreciation of our stock once its value goes higher than the strike price.
So, let’s start. Let’s suppose we want to buy the classic KO stock.
What are the price we should statistically looking at? They are the prices for which we know the probability of the same to be touched. As you may know, stock returns do not exactly follow a normal distribution, but this is indeed a good proxy and a good approximation.
For the benefit of who doesn’t have a statistical knowledge, if a random variable (stock return) is distributed according to a normal distribution, we can say that 95% of the outcomes will fall between 2 standard deviation, and 99% of the outcome will fall between 3 standard deviation. This will be more clear going forward.
Let’s assume i want to buy Intesa Sanpaolo stock, but i’m not willing to buy it at these prices or i want to take advantage of the options. Consequently, we will look at Put options at the expiry we want. As you know, a put option give the buyer the right to sell the underlying (ISP stock) at the strike price on the expiration date (in case of european options).
The first thing to choose is the expiry. I’m gonna use the puts that expiry the 17/03/2017.
Let’s at this point insert the right ticker and the right expiry date in the online tool, it will show up all you need to know.
ItalianDividends Tool
We need to change only the Yellow fields.
In this case we can see that the calculated strike for 2/3 standard deviations are 1.50 and 1.10 (forget about the $, quotes are in €, i’ll fix it). But you can also calculate the scenario which you’ll have inserting a custom strike (field D12).
The next thing to do is to plug the right premia in the E10:e12 range. Where do we get these? From the options book.
In our broker we look for the 17/03/2017 expiry ISP Put and the broker should come up with something similar to this:
These are the quotes for all the puts/calls with an active market for that expiry (if you go too far you might find no active market and consequently no price).
Remember, the bid is the price at which you can sell and ask is the price at which you buy.
For example: selling a put with expiry 20/05/2016 @ 2€ pays a premium of 0.053€/share. Given that the contract size for ISP is 1000 shares, that means 53€ for selling this option. If on 20/05 price will be higher than 1.947€ (2-0.053), you will have your written option expired and the money in your pocket.
At this point, which are the strikes we want to look at? We go back to the tool (image above) and we see that the calculated strikes are 2.10€ and 2.20€, respectively at 3SD and 2SD. These are not random numbers. The 2.10 strike is chosen because 99% of the times the spot price on the expiry date will be higher than that price. Same thing for 2.20, which will be lower than spot rate at expiration the 95% of the times.
Basically, what i’m providing to you is just a reference, based on volatility, for the price to be takes as strikes in buying/selling options.
Ok, let’s assume i’ve chosen the 2.20 strike. In that case quotes are 0.105/0.113. I want to sell so the price will be 0.105€/shares. If i sell at that price i will get 1000*0.105€ = 105€ premium – commissions.
But the tool is not useful just for reference. Plugging in the dividend for the year, the tool tells us directly the dividend yield on a monthly/annual basis. Ordinary stuff. The second Group tells us the breakeven price for the option (meaning, the true value under which a put will be exercised by the buyer) and the premium yield on a yearly basis. The third Group tells us the % distance from the strike and what happens in case of exercise or expiry. It is Worth noting the astonishing yearly yield in case of worthless expiry.
Ok, hope this is enough for the time being. Please be careful, options are not a joke. And also Always verify the size of the contacts (usually 100 shares).
I’m working on something more elaborated, i hope to end it by soon.
Thanks for following.