Monday, October 13, 2014

Cordier and Gross, The Complete Guide to Option Selling

In this, the third edition of The Complete Guide to Option Selling: How Selling Options Can Lead to Stellar Returns in Bull and Bear Markets (McGraw-Hill, 2015), James Cordier and Michael Gross explain how to use options to make money in the commodities futures markets. Most of their recommended strategies involve naked positions; only one, the vertical credit spread, is a defined risk trade.

The authors list seven reasons for preferring commodity futures options over equity options. Heading the list are substantially lower margins and high premiums for deep out of the money strikes. “With the SPAN margin system used in the futures industry, options can be sold for margin requirements as little as 1 to 1 1/2 times premium collected. For instance, you might sell a corn option for $600 and post an out-of-pocket margin requirement of only $700.” And “unlike equities, where to collect any worthwhile premium, options must be sold 1 to 3 strike prices out of the money, futures options can often be sold at strikes deep out of the money.” (p. 63)

Traders who want to delve into this world of high leverage and theoretically undefined risk had best know something about commodities. As the authors say, “’Know your market’ is every bit as important, if not more so, as ‘Know your option.’” (p. 343) The authors thus devote one part of the book to commodities fundamentals and seasonals.

Although they suggest that selling puts or calls can be a powerful strategy, due in part to “its sheer simplicity,” (p. 333) the “best option-selling strategy ever,” in their opinion, is the ratio credit spread. In fact, they call it the Maserati of option credit spreads. In a ratio credit spread you sell a certain number of options at a particular strike and buy fewer options at the “one closer to the money strike” in the same contract month. A three to one ratio “offers the best balance between potential for profit and risk protection.” (p. 160) The authors give examples of this strategy and offer a few tips for adjusting positions to reduce risk or increase profit.

As should be clear by now, the title of this book is misleading. It’s not the complete guide to option selling in general but a pretty complete guide to selling options on commodities futures. And since, as the authors readily admit, it’s difficult at best and in many cases impossible to extrapolate from commodities to equities, potential readers of this book should be looking to expand their options trading or diversify their portfolios by including short options on commodities futures. Otherwise, they should turn elsewhere.

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