Selling an option premium is an enticing proposition. You sell it, then you wait for implied volatility to come in or play the decay in your favor and take your profits. Can’t lose right?
Sadly, it’s not that easy. Selling premium has very significant, sometimes catastrophic risk.
Theoretically, you have unlimited loss potential. So how can a retail trader participate much the same way the big money does? You can sell an iron butterfly or an iron condor. They are essentially the same type of trade. It is just how the strikes are structured.
In an iron condor, the “middle”’ strikes are not the same strike and an iron butterfly has the “meat” as the same strike. You sell the “meaty” straddle or strangle and then buy a put further out and a call further out to cap your risk.
Let’s take the example of Hasbro (HAS). They report earnings this upcoming Monday before the open. Their average move on earnings over the last two years is 3.6%. Using the implied volatility for February expiration, we can calculate a one full standard deviation move of 6.67% in either direction.
That targets the 52.50 strike to the downside and the 60 strike to the upside. With HAS trading at 56.25 we can sell the 52.5/55/57.5/60 iron fly for $1.10 mid-market. If HAS stays between 55 and 57.5, you collect the entire premium. You break even at $53.90 (55-1.10) and $58.60 (57.5+1.10).
The most you can lose is $1.40 no matter what happens (2.5 max width less premium collected).
If HAS goes to zero, you lose $1.40 or if it goes to $1,000, you lose $1.40 because you capped your risk by buying the protective outside options. This gives a retail trader the ability to “sell premium” while keeping themselves in the game should the unforeseen occur.
