Secret 44 PROBABILITY—THE FIRST SECRET FOR OPTION WRITERS

From my experience the secret to winning at the naked option

writing game is to find very high probability plays. I write

naked options for speculation that have a very high probability of

paying off. With software that is now available (i.e. Option Master

®), you can measure the probability of a successful play.

Whenever you write naked options, you must use a stop-loss

to survive. I use a stop-loss based on the underlying stock, index

or futures, But even better, using a simulator, you can determine

the probability of hitting the stop-loss during the life of the

option.

I am always in search of a sure thing. Whenever the probability

of success is greater than 90%, I have a potential play. The

key to finding high probability plays is to write far-out-of-themoney

options. My best play was a Cell Pathways (CLPA) 7.50 put

priced at 1 ($100) with about 2 1/2 months before expiration, but

the underlying stock was priced at 48, a country mile from the

strike price. There was no reason to run the simulator, for the

probability of hitting 7.50 would have been 0.

However, a word of caution here. When an option is extremely

overpriced or extremely underpriced, there is probably a

reason. In fact, ironically, buying and selling stocks based on this

premise can be a profitable venture.

Here there was a reason; Cell Pathways, a drug company,

had a drug that was coming up for FDA review. However, after a

review of the price chart for CLPA, I found a lot of support at 10,

and I probably would abort or get out with a small loss if it hit 10.

The worst case scenario would be that I would get the stock

for a price of 6.50. (The put buyer has the right to put the stock

to the writer at 7.50, but I already had 1 point in my pocket, so

my cost is 6.50.) Even if CLPA were to go bankrupt without letting

me out of the position, an unlikely scenario, my maximum

loss would be 6.50. Here, I thought I had found a slam dunk play.

The extremely overpriced puts were a good signal that the

stock would decline, and it did down to 15 from 48, but that still was far from the strike price of the puts that I had written. I had

an easy win as I predicted.

You see, the option writers who write out-of-the-money options

have two factors going for them: time and distance. To get

writers in trouble, the underlying price must move against them

fast enough to beat the expiration date and far enough to hit

their stop-loss or strike price, sometimes an almost impossible

task.

From my experience the secret to winning at the naked option

writing game is to find very high probability plays. I write

naked options for speculation that have a very high probability of

paying off. With software that is now available (i.e. Option Master

®), you can measure the probability of a successful play.

Whenever you write naked options, you must use a stop-loss

to survive. I use a stop-loss based on the underlying stock, index

or futures, But even better, using a simulator, you can determine

the probability of hitting the stop-loss during the life of the

option.

I am always in search of a sure thing. Whenever the probability

of success is greater than 90%, I have a potential play. The

key to finding high probability plays is to write far-out-of-themoney

options. My best play was a Cell Pathways (CLPA) 7.50 put

priced at 1 ($100) with about 2 1/2 months before expiration, but

the underlying stock was priced at 48, a country mile from the

strike price. There was no reason to run the simulator, for the

probability of hitting 7.50 would have been 0.

However, a word of caution here. When an option is extremely

overpriced or extremely underpriced, there is probably a

reason. In fact, ironically, buying and selling stocks based on this

premise can be a profitable venture.

Here there was a reason; Cell Pathways, a drug company,

had a drug that was coming up for FDA review. However, after a

review of the price chart for CLPA, I found a lot of support at 10,

and I probably would abort or get out with a small loss if it hit 10.

The worst case scenario would be that I would get the stock

for a price of 6.50. (The put buyer has the right to put the stock

to the writer at 7.50, but I already had 1 point in my pocket, so

my cost is 6.50.) Even if CLPA were to go bankrupt without letting

me out of the position, an unlikely scenario, my maximum

loss would be 6.50. Here, I thought I had found a slam dunk play.

The extremely overpriced puts were a good signal that the

stock would decline, and it did down to 15 from 48, but that still was far from the strike price of the puts that I had written. I had

an easy win as I predicted.

You see, the option writers who write out-of-the-money options

have two factors going for them: time and distance. To get

writers in trouble, the underlying price must move against them

fast enough to beat the expiration date and far enough to hit

their stop-loss or strike price, sometimes an almost impossible

task.