 Hey all, this is Hop with XT and I just wanted to do this brief video for the less experienced traders out there on riding options. I'm sure many of you have seen that I like to trade options by riding them rather than buying them. So this video is really meant as an introduction to how and why I do it and hopefully will give you an insight for your own trading journey. So yeah, let's get to it. Bit of a disclaimer, I'm not a financial expert and this is all for your entertainment purposes so let's carry on. So why sell options? As many of you have probably experienced, when you buy puts or calls most of the time or a lot of the time, they don't work out. Apparently 80% usually expire worthless. The odds of buying a call or a put are usually the odds are stacked against you and that's resulting in the odds of return. So they're designed to pay well if they win and lose when they don't. As they always say, the house always wins. So that said, why be a loser in the casino when you can actually be the casino? So option basics. Probably an option is a profit function of strike price and time. You're determining what you believe the strike price of something is going to be and when it's going to be at that value. Problem here is that you have two independent variables that both need to work in your favor for you to make money. But by writing an option, you can remove one of these variables and really just turn that equation into simply profit equals a strike price. We've taken time out of the equation working against us and now it actually works for us. Now I've oversimplified this a bit, but for the purposes of the video, this is really what I want to get to. We are essentially picking a strike price and having time work for us. So how does it work? Well, it's exactly the opposite of buying an option. We instead of paying someone for the option at the start of the trade and then hopefully having that money increase in value as the trade moves towards the time and the strike price of the contract that we'd purchased, we make money by selling that contract to someone at the start of the day. And we are essentially selling a contract because we feel that the contract at the end of the day is going to be worthless. So we get our profit upfront. And then the objective, as I said, is that we want that contract to be worthless by the end of trade or by the end of the duration of that contract. So let's do an example. Let's say that we have the spy and we don't think it's going to close above 440. So how do we play this? Well, we're going to go and sell a core option above this strike price. So we don't think 440 is going to be breached. And we're going to put a little bit of buffer on there. And so we'll say, OK, we'll sell a contract example of 442. So we're hopeful that the day goes on and that the trade continues out, that this SPY does not go anywhere near 442. So the credit or the money that someone paid us to buy that contract at the start of the day is now all ours because the contract we gave them is now worthless. So I'm sure many of you have seen the options prediction tables like this and the estimate of the valuation of the option as the day ticks on. So I wanted to take this table and put it into something that's probably a little bit easier to digest for this example. And here you go. I've put a line here representing the valuation of the spy. And I've determined for the example of this discussion, I wanted to pick a worst-case example in that the spy just goes sideways. So if you bought a put or you bought a call this day, you lost money. In the blue line, however, it reflects the valuation of your contract. And again, I'm sure many of you who bought zero DTEs have seen the day tick on where the valuation of your contract continues to decline as the day kicks on. And eventually, if it didn't work out for you, it quates to zero. But what happens if you sold that contract at the start and we did everything in reverse? We make 100% of our money here and our obligation of our contract becomes worth less and less and less as the day goes forward, such that we get to a point where our obligation to whoever bought our contract is zero and we get to keep their money. So that is how writing an option works. So how do I trade this? There's really two ways to do it. You could just outright sell an option. Now again, to do a sale of options, you're going to need higher levels of option authority with your broker. Minimums usually level two or I want to say level three, depends on who you trade with. But basically put, they're going to require you to have a bit of money to back this up, especially if you're just selling an option naked with no cover and we'll get to what that means in the next step. The reason naked selling options is more difficult is that you need a lot of money to back it up. But secondly, there's an unlimited risk behind that in that you are obligated to pay whatever that option goes to. So if we have a day where some really bad or good news comes and your option isn't positioned correctly, you could be in for some significant losses. The other way to play this is an option spread. You're capping your losses in this case, your risk is capped and you have a limited capital requirement to back it up because you have got an insurance policy. So for most traders, the spread is going to be your best option. So how do you do a spread? Well, you take or you sell an option that is close to the current strike price. So that's going to be our basis for making money. If we were to do a naked, this would be our only option. We wouldn't do any others. We would simply sell an option that we feel is near enough to the money that is going to be profitable, but is not near enough that it's going to get hit. Our insurance policy, though, here is that we buy an option that's further out of the money. So that's our effective insurance policy. So we basically make money because the option we sell is close to the money. So therefore it's worth more. And our insurance policy is further away from the money. So it's worth less. So the difference between those two is the credit, which ultimately, if everything works out, is a loss. It's our profit. So let's do the spread example. So we have 442 that we were going to sell from a previous example, but we don't want to do a naked option. We want to limit our risk and we want to cover ourselves with a 443 call. So we are now doing an option spread. So we sell the 442 at $64. But we go and buy insurance by getting the 443 at $339. So we're basically saying here that we believe that the strike price is going to end the day below 442. But should it go higher than 442, we have a 443 call that's going to gain in value as this gains in value. So we are limiting our potential loss. So if the day closes at 444, we know exactly how much money we owe. It's not an unlimited amount. It's a set amount because we have this insurance policy. So we look at the difference between these two and it's $25. So that's our credit. That's our money that we get to keep. So what's our maximum loss here? Well, it's the difference between the two strikes. So it's going to be $100 again because we're dealing in contracts. We're there $100. I'm sure you guys know that. But we've already been paid. We have a $25 credit. So really, our maximum risk is the difference between the two strike prices, less the money we get paid for up front, which is $75 in this case. In this case, we close before 442. This $25 becomes 100% ours. And as you can see in the graphic here, our margin that we require the capital that we need to have is going to be $100. Our maximum loss is going to be $75. Our maximum profit is $25. That's again, assuming that we just walk away and we don't manage this trade. We're going to get to that a little bit. But spreads are not a set motion agreement. They're just like any other option. You can buy and sell them at any time. There's still money or sorry, time on the contract. So graphically, we can see the trade here in front of us. The purple line represents the price of the spy. And as we've said before, we're going to assume the worst case scenario for option buyers is that the spy itself does not move the entire day. It stays the same constant price, meaning if you bought a put or a call, you didn't make any money simply because the spy itself didn't change value. You probably lost money because the value of your contract decreases over time, which is what's represented here in the green and blue lines in that these are the valuations of the contracts that we sold in green, but ensured ourselves by buying a cover in blue. So the green represents the 442 call that we sold. And the blue represents the 443 call that we bought to cover ourselves and ensured the price of the spy appreciate instead of decline or go sideways like it did today. So we can see here right here that the value of the green call that we sold, the 442, was somewhere around the mid 60s. And the value of our insurance of the 443 was somewhere around the mid 37, 38. So we sold something for around 65, 66 cents. We would then subtract the value of what we buying as our cover and this distance here, that's our credit, that's the money that we get to keep should the trade work in our favor. And as we can see as the day progresses, the value of both call options declines as the time goes through the day. So ideally in the ideal world that the option that we sold and the option that we bought have a value of zero because both options would expire out of the money and have no value. It can also be noted here that you could exit this trade anytime during the day because you can see here that these options have value. This green line is our liability because we sold an option. So we owe someone money for that option during the life of the option. But as we can see here as the day has gone on, the value of that contract has reduced. So if we needed to get out of the market or out of the trade in the middle of the day, we would need to buy the option that we sold. But if we were needing to get out, we would now only need to buy it back at 45 cents and we sold it around 65 cents or so. So we profit from that difference because obviously we sold it at a high price and we purchased at a lower price. So we're doing a reverse trade of usually buying and selling. We are selling and buying. But also our insurance policy still has value too. So we can sell that and that would be our maximum trade. That we would still leave money on the table because obviously this decline is value that we're not taking but say we thought the market was going to go against us or we need to do something else during our day. We can simply disclose the trade out at any time we want and you're not locked into it. Again, this is on the assumption that we're going in our way but what happens if this trade was going the other way against us? We can gain the same principle. We can close it out and you don't have a maximum loss. Sure there will be a loss because the value of this contract is actually going to appreciate. But so is the value of our call. Granted it's probably not going to appreciate as much as this guy because it's close to the money but the principle is still the same is that you can still get out without a maximum loss. So by purchasing the insurance it enables you to limit how much to risk you have on the table at any time. So what do I write options? They're easily managed so I don't have to sit behind this computer every minute of every trading day and I can go ahead and do other things. I work full-time, I work from home. So for me to sit and watch this SPY or whatever other index we're trading that day I have other obligations to meet. So by selling an option or an option spread I can position it such that I can set it up and get to whatever other things I need to do in the day. I can set up an automated alert so should I need to get involved I can get myself involved but I don't have to be physically there 100%. My mind can be on other things. Again we can manage the trade. It starts going against us. We can exit before we're looking at a maximum loss. And by selling an option I'm putting probability in my favor and I'm also having time of theta if you're in the Greeks is working for me rather than against me. And this is really for me it's beneficial because I can go and work my full-time job while still being quote-unquote an active trader. But what are the disadvantages of writing options? It requires a lot of discipline. You've got to have a trading plan, you've got to have your stop losses and you've got to stick to them. As you've seen the liability is going to be a lot greater than your potential credit so if you don't manage these correctly you could be up for significant losses in comparison to your potential credit. These are really not suitable for volatile markets so if it's a wild day don't do it. If it's a wild week don't do it. If we're going to get some news that potentially could swing a market don't do it. Things like the news, the Federal Reserve, inflation numbers, job numbers, anything that could really significantly impact the market is probably not a good day for you to write an option. You can also be assigned an option depending on the security that you're using. Now I trade SPX so this for me is not a problem. Again this video is really an instructional video of basics of writing options. I will probably get into how I personally determine my strike price of options, my methods and how I like to manage them in other videos but the purpose of this video was really just to get a baseline understanding of how to write an option and the theory behind it. So for those hoping to get my thoughts we'll get there but just not today. But I will give you some little things that I like to do personally and so it'll give you an idea of how I think when I'm doing my trades. I don't trade the first out. I let the market do its thing. There's just too much volatility and as we've seen volatility and spreads and selling options don't mix. So I just let it be. I like to trade SPX simply because it's cash settled. I can't get assigned. And also the number of options that I'm trading from a perspective of commission it's a lot cheaper to use SPX and there's also taxation reasons it's more beneficial but again that's an SPX versus SPY thing. I like to set my spread according to what I'm seeing like if it's a trend day or a range day and again these are things we can get into in other videos. I like to set an alert. Sometime before my strike price I'm not going to set it directly at my strike price. I'd like to know give me some forewarning that hey the trade of the day is working against where my spread's at and I won't pay some attention so I will set it up so it's going to give me an indication that I need to be actively involved in the trade. Now you've got to be disciplined. For me if my strike price is hit and I get a confirmation that the next five minute candle is above my strike price I'm just going to exit. I'm going to eat that loss. I would rather lose two hundred percent three hundred percent rather than lose six or seven hundred percent of my credit. I'll just accept that I made a bad call that day. I'll lick my wounds and I'll come back the next day and make it back. And with these spreads now particularly for zero DTE type spreads if you're in the money in the last hour of trading and you start seeing things looking like the market is going back towards your spread just close it close that spread lock in your gains you better off with a 90% win then trying to go for your hundred and then getting ruined in that last 10 15 minutes when there's a huge spike in trades that just triggers your option spread. So it's just not worth the risk. Anyway this has just been a really brief video on how to write options and how they can work for you. If you've got any questions at all be really glad to help. You can hit me up with the comments in the DMs. Any of the XT guys here will be more than happy to help. This is our community. We're here to help you. You're here to help us. We're here to learn from each other and grow as traders. So that's it. It's been a pleasure. Hop out. There's a reason why Xtrades is currently the fastest growing application on the market for sharing financial ideas. With over $2.5 million paid in the last two years to contributors, users are flocking to see what trades the top traders on the leaderboard are sharing in real time. If you're looking to grow your reputation as a trader on the internet or discuss your trading ideas with other reputable investors, click the link below and get connected with a trading mentor today completely free of charge.