From the February 01, 2011 issue of Futures Magazine • Subscribe!

Seven ways to collect higher option premiums

As a group, option sellers tend to be efficiency oriented. Always attuned to maximizing odds, sellers key toward being efficient, and efficiency often can mean getting the most bang for your buck.

To option sellers, that means collecting big premiums.

There are many ways to bring in higher premiums for the options you sell. Leaning toward a more risk-averse stance, not all of these methods are advocated all the time. However, taken as a whole, these techniques will provide a solid primer and a broad arsenal for generating the maximum amount of premium for your account when you write options.

1. Sell naked

Spread positions have merit, but for pure premium collection, there is no way to get bigger premiums — and realize those premiums more quickly — than selling naked positions.

While the word conjures up images of being exposed to too much risk and thus discourages many investors from exploring it, naked option selling can be done responsibly and effectively. It’s the cornerstone of the option-selling philosophy.

While naked risk must be managed more closely than covered risk, you are doing yourself and your portfolio a disservice if you do not consider selling naked in at least some situations. It’s the power play, the strong side sweep and the right hook in an option seller’s arsenal.

2. Sell strangles

Selling strangles is a popular option strategy. While not ideal for hard trending markets or breakout moves, selling strangles (selling a put and a call in the same market) can be an amazingly versatile strategy. It can be deployed in a wide variety of market conditions and has a magical effect on boosting your premium: Doubling your premium collected while reducing your margin requirement (as a percentage of that premium).

For instance, selling the put may bring in $500 premium and carry a $1,000 margin requirement. Selling the call may do the same. But selling them at the same time brings in the same premium but lowers the margin requirement. Thus, selling the put and call together brings a greater return on invested capital.

As a bonus, selling a strangle also comes with some built-in risk temperance. A move against your call is at least partially offset by gains in your put (and vice versa). Thus, a strangle can be a flexible way to build account premium quickly.

3. Sell closer to the money

While not the first choice for collecting higher premium, selling options with strike prices closer to the current market will increase the premiums you collect (see "The money’s in the money").

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For the risk-averse trader, this may be troubling because the closer you sell to the money, the better chance for your options to go in the money — a place no option seller wants to be. But, moving a strike or two closer sometimes can make a big difference in the premium you collect, especially in markets where deep out-of-the-money strikes are available and fundamentals support your position.

For instance, if coffee is at $1.50 per pound, it probably isn’t going to make a big difference from a risk standpoint if you sell a $2.90, $2.80 or $2.70 call. But it could make a noticeable difference in the premium you collect. In this type of situation (all strikes are deep out of the money), selling the closer strike can make sense.

4. Sell more time

This is a more conservative method of collecting higher premiums than selling closer to the money: Sell options that are further from their expiration date. The more time left on your option, the higher the premium you can collect.

The tradeoff is that you have to wait longer for the option to expire. Many traders do not have the patience for this. Others feel that selling more time allows a greater window for something to happen in the markets that moves against your position. If you want to reduce the chances of something happening in this sense, know your fundamentals and seasonals. Sharp moves can happen in any market. However, they are less likely to occur in markets where fundamentals do not support them and often are limited to specific seasonal periods.

Selling more time can be a slow path to higher returns.

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