Good Place to Sell Upside Volatility

Implied volatility spiked massively as crude prices fell on Friday. This has created a good opportunity to sell out of the money calls to partially offset positions taken during our earlier buy call. Selling upside calls allows you to hedge some of your delta (i.e. reduce the risk of your position), while taking advantage of high prices for volatility (and some time decay) to increase the profit potential of your position. Implied volatility is now at 47 which is a historically high level and usually a good place to sell out of the money options. As you'll see from the following, I recommend selling high out of the money options. I am bullish on crude long term and would never want to sell options that could expire in the money.

I recommend selling the Dec 2011 200 crude call option. While these options were marked at .39 (+.02 in spite of crude falling $3), they traded between .50-.65 on Friday. I would sell these options aggressively above .50. The idea is to partially hedge your underlying crude position so I would sell 1-2 options per underlying contract. This enables you to take in $.50-1.30 per contract. While it only reduces your delta by 2-4%, you are now short volatility and long time decay. This position should be profitable as long as there isn't a an event (most likely a war) which causes a massive spike in crude prices and the position will only increase overall risk if crude prices exceed $200 over the next 18 months. Crude hitting $200 in the next 18 months is a very low probability event and is more than compensated by the fat .50-.65 premium currently priced into these options.