John Jagerson

Trading Where You Think Prices Won't Go

by John Jagerson   06/25/09

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The market channels frequently. This is tough on active traders as channels can be very difficult to trade.

Sometimes these channels coincide with very important and widely anticipated news events. The passage of the stimulus and the bank bailouts are great examples of this kind of situation. Traders are faced with a tight market that may or may not break out of its channel.

In these situations, it might be easier to trade where the market won't go rather than where you think it will go.

Option sellers essentially trade this way all the time. Selling options is a great way to take a non-directional trade and turn the disadvantages of buying options into advantages.

In the video below, I cover some of the basic ideas behind selling a forex option and how that can work to your advantage in a channeling market. (Learn more about trading forex options.)

Selling or writing an option means that you are opening an option trade by selling the option short. When you enter this trade, you are paid the option cost, or premium, up front.

There are a few significant factors to consider as you evaluate and enter this trade. We will walk through each of these issues in a case study.

Selling the Option

Selling out-of-the-money options is a great way to start using this strategy. Although it is perfectly acceptable to sell in-the-money options, new options traders will usually start the other way around because it seems a little more conservative.

Selling an option means that there are two market conditions that will result in a profit. First, the market could stay flat, which will result in you keeping the premium of the option you sold. Second, the market may trend the direction of your forecast and you will still get the maximum profit.