CHAPTER 5
An Introduction to Volatility-Selling Strategies
Along with death and taxes, there is one other fact of life we can all count
on: the time value of all options ultimately going to zero. What an alluring
concept! In a business where expected profits can be thwarted by an
unexpected turn of events, this is one certainty traders can count on. Like all
certainties in the financial world, there is a way to profit from this fact, but
it’s not as easy as it sounds. Alas, the potential for profit only exists when
there is risk of loss.
In order to profit from eroding option premiums, traders must implement
option-selling strategies, also known as volatility-selling strategies. These
strategies have their own set of inherent risks. Selling volatility means
having negative vega—the risk of implied volatility rising. It also means
having negative gamma—the risk of the underlying being too volatile. This
is the nature of selling volatility. The option-selling trader does not want the
underlying stock to move—that is, the trader wants the stock to be less
volatile. That is the risk.