I can make the Green$ with this!
Options tend to lose value over time for many reasons. Options at or near the money are especially at risk to losing value, because the ‘time value” portion of the option is so rich in price. (An Option’s price is made up of the intrinsic value and time value.) Given the premise that most Options tend to lose value, wouldn’t you want to be selling them? Sounds Simple! But what if the Option pays off and is a winner? Well we have to employ a strategy like insurance companies, where we sell insurance on many homes for fire and if one or two burns down, then the premiums from all the others are still enough to keep the company profitable. (THERE I SAID IT, INSURANCE COMPANIES ARE LEGALIZED GAMBLING!) Anyway I digress.
This strategy of selling multiple Options for profit is very easy to validate. Do this on paper, because there is a huge margin requirement to sell naked Options. (My brokers risk department is always calling me on Fridays to make sure I am aware of my risk) If you sell an Option and do not have the underlying security to give to someone if they exercise the Option, then you are selling the Option naked. Naked Options will cause your margin to be eaten up very quickly.
OK let’s validate this strategy of selling multiple naked Options. On any day sell any ten Fx Options at or near the money. Make sure each Option is approximately the same transaction amount for dollar cost averaging. On the third Friday of the month when the Options expire, buy back all ten Options and net out your gains and losses. There is an excellent chance that you made money. If you have access to historical data, try a few other months. It’s a very profitable strategy. . . if you have unlimited margin.
Investment companies (Goldman, Morgan Stanley, Saxo Bank) have unlimited margin, Insurance Companies, Casinos, and Banks have unlimited margin. That is why they are making money and have going concerns, they have almost unlimited capital and can spread their risk over many investments where the odds are in their favor. Even if these companies have a bad streak, they are too big to fail and the government will bail them out. . . . I digress again.
We now have our strategy. Selling FX Options is a profitable tactic because Options lose value more often than not and we have the data to prove the strategy. Investment banks, casinos, and insurance companies do this everyday using their unlimited cash reserves. They are making the market in most of these Option strategys. Now that we understand their business model and how they are hedging and taking our money, we now have the ability to take away some of their profits by the way we place our trade. Trade naked Options like a market maker!!
Placing the trade will be the next article on FX options, but until then sign up for our free nightly FX Options Sentiment analysis so you can see where FX Options trading is taking place and where traders are hedging.
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