Explore Your Options by Tom Gentile
MAKING BETTER "CENTS" OF A SALE
Is selling an at-the-money (Atm) or out-of-the-money (Otm) option really better than selling a contract that has more premium attached to its market price due to its intrinsic worth?
That’s a tricky one. As for which type of sale constitutes the “better” one, we do know selling extrinsic or time premium associated with Atm or Otm has the advantage of time decay. All options do lose 100% of their extrinsic value by expiration. However, whether a contract lands in or out of the money and by what amount can prove to be the more important factor in calculating actual profits and losses.
At the end of the day, it does a trader little good if they’ve sold an Atm contract for, say, $1.25 with 100% extrinsic value if it loses all that value but is worth $10 intrinsically come expiration. Bottom line, if the trader failed to hedge the contract’s delta risk as the rise in shares created real value for either the short call or short put, he or she would be out $8.75.