Scenario-checked short-call income versus directional premium

This archive article walks through one early-August 1988 index-call sale. In the historical workflow, a directional opinion was combined with theoretical value by running a computer price simulation of the intended position before entry.

Directional buying and relationship trading

Option use is split into two habits. One is directional premium buying driven by news, published forecasts, or chart reading. The other is relationship trading, which compares live prices with theoretical value and often uses spreads.

That second habit treats listed premium as cheap, fair, or rich. A May 280/285 call spread was treated as cheap at a 1-3/4 debit, fair at 2, and rich at 2-1/4. Forecasting implied volatility was used to buy underpriced options and sell overpriced ones, typically in large size with a thin margin per trade.

Combining a view with a price simulation

Buying premium without implied-volatility work and what-if price paths was contrasted with futures. Futures were framed as a simpler directional vehicle with less time decay and less implied-volatility exposure.

A directional opinion was combined with theoretical value by running a computer price simulation of the intended position before entry, so that setups that looked attractive without that check could be rejected.

The August 1988 short-call sale

In early August 1988, with about two and a half weeks to expiration and a broad equity index near 259 after a 150-point advance, 150 of the August 265 calls were sold at 1-11/16. Those strikes sat above the index, so the sale was an out-of-the-money call form of premium selling.

A price simulation that lifted the index three points to 262 and removed three days, while holding volatility unchanged, showed those 265 calls only slightly richer. That path implied a small mark-to-market loss if the market drifted higher. The short August 265 calls were the position that went to market after that check.

Weekday timing, cushion, and long puts

Premium was more often sold on Thursday or Friday because subtracting three days of remaining life cut theoretical value sharply. Short-term volatility was left unchanged in the price simulation because it was treated as hard to forecast.

Out-of-the-money calls were sold instead of at-the-money calls to keep a price cushion. Short calls were preferred to long puts because direction and timing could be somewhat wrong before losses accelerated. Remaining life and distance to the strike were the cushion that let premium selling survive a mild miss in direction or timing.

Long puts were used as an imperfect hedge on long stock holdings rather than as the main bearish vehicle. A long-put stance required nearly exact timing, or time decay eroded the position.