Most energy traders, professional and amateur, are drawn to energy commodities futures trading because they are aware of the potential for very large profits, using little capital. However, knowing the difference between potential profit and potential for profit is what separates skilled traders from the pack. This is especially true in energy commodities options trading.
Numerous studies have shown that 80% of commodities options expire worthless. While commercial traders may be offsetting these losses with gains on the physical product price movements, the vast majority of traders are unhedged and experiencing pure losses. The problem is that most traders plan a trade based solely on profit expectations and not on the probability of exiting the trade profitably.
Energy options traders are particularly vulnerable to this trap. The leveraged based margin requirements of commodities allows a trader to control a large position using relatively small premium. Traders will often receive additional incentive from their options broker reminding clients that the risk in buying a put or call is limited to the premium paid.
The problem is that the options buyer is not much different than someone trying to beat the house in Las Vegas. That is why I prefer to be the house by selling options, rather than trying to beat the house by buying options.
By selling options, I am limiting the potential for profits. I am also exposing myself to unlimited risk. However the reason this strategy works so well is that I have improved my probability of success to 80%.
Just like the Vegas casinos I have to have enough capital on hand so I can pay out the occasional losing trades. However, by carefully monitoring the market I am trading, I am able to limit these losses by exiting losing trades early and allowing the winning trades to provide a steady income stream.
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