Unhedged option income with volume and the midterm trend

What counts as unhedged

Retail commentary routinely ranks unhedged option selling among the most hazardous activities available to individual traders. An unhedged write is option writing without an offsetting long position in the underlying or a similar long option.

The writer receives a premium up front and can keep only that limited amount. A large move can force an expensive cover, so brokers typically require extra margin and equity.

How the short is closed

The unhedged writer wants the option's value to fall after the sale. The typical close is a cover that buys the contract back cheaper. The writer may hold instead if the contract expires with no remaining value.

If a short option still has value at expiration or is exercised early, the writer can be obligated to buy the underlying after puts or sell it after calls. Most options are closed in the market before expiration rather than exercised.

A direction bet and a duration bet

Selling puts and buying calls can both express a bullish view. The writer also benefits when the option behaves as a wasting asset. Time decay is the tendency of an option's value to decline as expiration approaches when other factors are unchanged.

Because the position combines a direction bet with a duration bet, the writer can profit from no movement, movement away from the strike, or a failed directional forecast.

Sizing before the sale

The case frames profitability as many more winners than losers while accepting that an infrequent loss can be several times the typical gain. It treats losses on the order of two or three times that typical gain as a trade-management benchmark.

Three sizing styles are distinguished: reinvesting principal plus profits, a fixed portfolio fraction, and a fixed dollar amount. Full reinvestment of principal and profits is marked unsuitable for options. The stated tests are recovery from losses, compounding, and avoiding total wipeout.

Volume that licenses a write

Entries are keyed to surges in a volume moving average, read on weekly as well as daily charts of the underlying. Support volume is a surge during a market decline. Resistance volume is a surge during a market rally.

Those write signals are not identical to signals from a companion option-buying rule set.

When the intermediate trend is known

The write is treated as a leveraged way to follow the underlying's intermediate trend. That midterm regime is described as about six weeks to three-to-five months. The workflow often uses options three or four months from expiration.

The write is described as dangerous when that midterm trend is unknown.

Income is not return on margin

Income-style profit is calculated as the difference between sale price and cover price. Return on margin is distinct because it includes the cash or securities posted to carry the write.