Iron Condor

The first time someone tried to explain the concept of option selling to me I had a near brain meltdown.

Okay, maybe that’s a little over dramatic – but it was something that was a bit difficult to wrap my head around – and after coming to understand the concept and then trying to explain it to others – I see the same cloudy confusion in most of them as I had when it was first explained to me.

It probably has to do with the fact that when you are selling options – you are selling something that you don’t own. And because I couldn’t relate that to anything else I had hear about or experienced it didn’t make much sense.

When one is trading options it is true they are allowed to sell something that they don’t own – however – they do need to prove that they have the capability to purchase it. They need to prove they have the means – the assets available – the cash in the bank so to speak.

Basically your broker is doing you a favor to sell an option that you don’t already own – however your broker isn’t stupid either. They are going to want to make sure if needed – you DO have the assets to purchase. There is no free ride.

Ways to prove this could be cash in your account – stock in your account – or simply through buying a corresponding call or put nearby ‘covering’ your sold – naked – short position.

A reason traders like to sell options rather than buy them is due to the fact that options are continually using value due to theta decay. Rather than purchase a decaying option – it is preferred to sell it to someone else.

Ways that a trader can benefit from option selling while still limiting their risk is through the use of option spread strategies like the iron condor, the butterfly spread, the double diagonal, the calendar spread, and the credit spread / vertical spreads.

photo credit: TheTruthAbout…