2007issue C111-3
Ranking short options by premium, margin, time, and delta
Short-option candidates that differ in strike, margin, and expiration can be compared as a capital-allocation problem. Premium, posted margin, days to expiration, and absolute delta form a composite ranking. Screening only on implied-volatility richness or on shared support and resistance is incomplete.
- Short option sales can be compared as a capital-allocation problem because candidates differ in strike, margin, and expiration.
- A composite of the premium-to-margin ratio, the time-normalized rate, and one minus absolute delta ranks unlike sales. It does not identify which options will expire worthless.
- Screening only for implied-volatility richness, or only for strikes beyond shared support or resistance, is incomplete.
- A higher screened potential rate is not determinative if the higher-ranked market moves against the short while the lower-ranked market does not.
Unlike short options as a capital-allocation problem
Short option sales can be compared as a capital-allocation problem because candidates differ in strike, margin, and expiration. A first comparison divides collected premium by posted margin.
The premium-to-margin ratio is collected option premium divided by the margin posted to carry the short option. In the worked pair, a 400 credit on 17500 margin is 2.28 percent, while a 250 credit on 1080 margin is 23.15 percent.
Time-normalized rate and absolute delta
The time-normalized rate is that premium-to-margin ratio divided by calendar days remaining to expiration so contracts with different expiries can be compared. Adjusting those ratios for 25 versus 61 days to expiration yields about 0.09 percent versus 0.37 percent per day, shrinking a roughly tenfold premium-to-margin gap to about fourfold.
Absolute delta is the unsigned delta used as a stand-in for the chance a strike finishes in the money. One minus that value estimates the chance it finishes out of the money. Scaling further by one minus absolute delta of 0.30 versus 0.20 produces about 0.06 percent versus 0.30 percent per day in the same pair.
The composite uses premium, margin, days to expiration, and absolute delta as a probability analog. It does not identify which options will expire worthless.
Why single screens are incomplete
Screening only for high implied volatility is incomplete because an expensive option can remain expensive while the underlying stays unusually active. Implied-volatility richness is a reading that an option looks expensive versus a model or recent history, and that richness can persist while the underlying stays unusually active.
Screening only for strikes beyond shared support or resistance is incomplete because other traders can sell the same levels and compress premium. Support-resistance crowding is the tendency for many traders to sell the same strikes just beyond shared chart levels, which can compress available premium.
A higher screened potential rate is not determinative if the higher-ranked market moves against the short while the lower-ranked market does not.
An initial screen, not a replacement
The comparison is described as an initial screen to combine with pricing models and chart work, not as a replacement for either.
All readings on this track · 10 readings
- 1998Strike selection from a return distribution and implied volatility
- 2004Constructing an index-options overlay with dividend premiums and open interest
- 2005Implied volatility and price divergence as a sentiment regime filter
- 2007Ranking short options by premium, margin, time, and delta
- 2008Bull put spread construction under elevated implied volatility
- 2008Net time-value ranking for conversion spreads
- 2008Out-of-the-money commodity credit spreads in a volatility regime
- 2012Far-spot option-elasticity and percent-theta limits
- 2012Weekly debit spreads and volatility regime matching
- 2018Constructing option strikes from intrinsic and time premium