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Counter Trend Option Trading

01/10/2014 6:00 am EST


Carley Garner

Senior Strategist & Broker, DeCarley Trading, LLC

Carly Garner discusses a counter-trend option selling strategy to take advantage of over-priced options.

SPEAKER 1:  My guest today is Carly Garner.  We’re talking about countertrend option selling, what that is and the strategy that she uses, so Carly first of all define what that is.

CARLY:  Countertrend option selling is obviously option selling, but the idea of it is you’re looking to take advantage of options that are overpriced in a market that’s in an incline or a decline and tends to see the bandwagon traders buying.  For example, if the market’s rallying and it’s been doing so for a period of time, everybody assumes the trend is going to last forever, the trend is your friend traders, and so what they do is they buy call options and as they’re buying calls out of the money it’s bidding the price of them up, so as an option seller we look at those and we try to take advantage of the fact that possibly those calls are overpriced because they’re in high demand and so that’s what we’re looking at.  The idea of a countertrend trade is not necessarily in a perfect world if we sold the call we’d want the market to go down.  That would take all the guessing out of it and it would just be an easy trade.  It doesn’t always work that way, but that’s the goal.  Ideally, the strategy itself can make money if the market goes up, down, or sideways. The only risk is if it continues to go up too far too fast, so there’s a lot of room for error.

SPEAKER 1:  What if things give you the clue that something is overpriced, that it’s worth selling because it will be worth less later and you can buy it back.  What are you looking at?

CARLY:  We look at a lot of things, but one thing that I really look for is an option that’s exploded.  For example, if we see an option that was maybe worth $100 last week and this week it’s worth $500 or $600 because the market’s excited and the volatility is high, that’s an option that we think hey it’s probably overpriced.  If it went from $100 to $600 in a couple of days, if the market calms down and trades sideways, or at least even if it just stops moving as fast as it’s moving now a lot of times the options will lose value, and so that’s what we’re looking for is just big explosions in options pricing.

SPEAKER 1:  Do I have to know about the Greeks?  I mean is there one that says this Greek is overpriced and it would give me a clue?

CARLY:  Every option seller is different.  Some people live and die by the Greeks.  I glance at them and that’s about it.  I really don’t do much else in that.  I look at the Delta so that I can kind of see how fast my options going to move versus how fast the futures are moving, but other than that I don’t delve too much into it.

SPEAKER 1:  Okay.  Do you find that strike price is right at the money?  Is that the one you’re looking at typically? 

CARLY:  The thing about trading is you want to make sure whatever you’re doing fits your personality so that you’re not uncomfortable, because when you’re uncomfortable you panic and you make bad decisions.  For me, personally, what I like to do is go way out of the money, so we’re usually looking at Deltas anywhere from 10 to 20 and a Delta is just quite simply, if anyone is not aware of Delta, it’s how fast the option price moves relative to the future.  If you have a Delta of 20 your option is only going to move about 20% of the amount that the futures moves, so we try to keep it out of the money enough to where we can sleep at night and we don’t have to hopefully worry about it.

SPEAKER 1:  Alright, so once you’ve sold it how do you know then that it’s time to get out and you’ve made your money?

CARLY:  Well if everything goes perfectly, and it doesn’t always happen that way, but if it does within a week or two we’d like to exit.  That’s kind of our timeframe, which is different than most options sellers.  Most options sellers put it on and they just kind of expect to hold its expiration and that’s it.  We’re a little more proactive in the trading, but the rule of thumb is if we sell an option and it loses about 80% of its value, give or take, at that point we just pull the plug on it because I’ve seen a lot of trades go bad, you know people trying to squeeze out the last $50 of an option and they’re just in the wrong place at the wrong time and that $50 option turns into a very expensive mistake. 

SPEAKER 1:  Get out while you can and take it.

CARLY:  Exactly.  Take the money and run.

SPEAKER 1:  Carly, thanks for your time.

CARLY:  Thank you.

SPEAKER 1:  You’re watching the video network.

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