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Option Trading Basics - Q&A

HAVING TROUBLE PRINTING?
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One of our readers asked why we would sell puts on an issue (such as Marvell Technology Group - MRVL) that has an earnings report due prior to the expiration date of the options...

Buying calls and puts generally requires timely, directional movement in the underlying, in order to achieve a profit. However, when you are long a call or put, there is also the potential for a decline in option "premium" after an important event or news announcement. Indeed, you can still lose money despite the fact that you correctly forecast the stock's activity after an earnings report. That would be the major reason not to stay "long" across the actual reporting date; the option values will deflate in all but the most volatile post-announcement moves.

In contrast, the approach we use in the OW portfolio involves "selling" options, most of which are deep-in-the-money, thus an earnings surprise will have less effect on the distant strike prices and larger movements can be absorbed before the position becomes unprofitable. Of course, that doesn't mean you sell options across earnings without regard to the stock's current technicals, sector relative strength, past surprise history, etc.

In all cases, remember that each candidate offered in the OW portfolio must meet your personal criteria before being considered a favorable option trade. Once that has been determined, an exit strategy, including a specific point at which the sold (short) option will be closed, should be established before opening any new position.

OW Staff

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