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A lot of traders move from buying options to selling options. Though in India since margin blocked is too high to sell options, many traders are unable to sell it. Moreover many traders do not want to sell options as they think its unlimited loss.
Huge margin blocked plus the unlimited loss combined effect stops many option traders to sell options. Some who want to sell, do not have the money to sell options, and those who have do not want to sell because they cannot overcome the fear of unlimited loss hovering their minds plus the greed to make unlimited money stops them from selling options.
Selling options can be dangerous if the stock moves against the sold option rapidly. If you leave a sold option overnight then a gap opening against sold options can be dangerous too.
Things to Keep in Mind When Selling Options:
1. Keep a limit on Position Lot Size:
If your account is 10 lakh it’s foolish to use entire margin to sell options without hedge. At max you can sell with margin blocked not over 5 lakhs otherwise you are taking too much risk.
2. Do not sell At The Money (ATM) Options
For overnight positions selling At The Money Options is not recommended. This is one option that will become In The Money even with a small move of the stock against it.
3. Create a Spread:
You can create a spread by buying a call option at a higher strike price than the short call option you sold. Once you create a spread it is known as a call credit spread. Though it may not help as much as you think, but creating a spread limits the loss from the time you create it. That way you can wait for a reversal if you want. If it does not reverses still your losses will be limited to the time you created a spread.
Note that creating a call credit spread will need some money because you will have to use some of the premium that you collected on the short call option to purchase and protect using the long call option. This will reduce your potential profit, but it will help limit any additional risk involved in the trade.
4. Sell A Put:
This is done by a lot of traders worldwide. What they do is sell an ATM Put where currently the stock is. However selling a put has limited potential to curb the loss from selling the call. However it does limit the loss to some extend and gives the trade some time to relax. If the stock remains in same place for long – the trade may make money from both the call sold and put sold. However if the stock reverses, you may have to exit the put sold to limit the loss from it. If it does not – you can sell one more put at the next strike collecting more premium to limit the loss in selling call.
This is some great ways to adjust a losing call sold position. But more than the adjustment make sure ghat your position size is appropriate to what you can manege before the trade goes live, else it gets hard to manage. Please note that any of the above adjustments will not work if you have too big of a position size.
So your first adjustment should be to reduce the lot size traded.
Hopefully this article helps you. If you have any questions, you can write in the comments section.
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“buying a call option at a higher price than the short call option you sold”
Won’t this be debit spread?
higher price mean higher premium of higher strike?
By higher I meant higher strike. I have edited the text. Thanks.