Here's a short checklist for what to play and what not to play with options, with an emphasis on what to look for in premium selling setups, as well as a few guidelines as to what to do once you're in the trade:
1) High Liquidity. Look for average daily in the underlying of at least 2 million shares. If of the actual shares is less than that, in all likelihood you'll be staring at wide bid/ask spreads in the options, which means you're less likely to get filled on any options order for a "fair price" (i.e., a price at or slightly above the mid price). Even if the underlying trades more than 2 million shares, pass on trades where the options' bid/ask spread is grotesquely wide.
2) No Weeklies, No Go. Truth be told, I have, on occasion, played for underlyings that only have monthly expiries available; most of the time I've regretted it. They're a pain and offer less flexibility with rolls than with underlyings that have weekly expiries. Premium selling plays are meant to be quick and dirty; the sooner you can get out of the play and redeploy the capital elsewhere, the better, and being stuck in a play with only monthlies can prolong the process. Additionally, having weekly expires are a hallmark of greater market interest in the options.
3) Both High Implied Rank/High Implied Volality. Look to enter trades where both the implied rank is greater than 70th percentile and the implied is greater than 50% (i.e., where the implied is high now as compared to where its been and where the implied is currently high). Keep in mind that you're looking for a contraction when selling premium around , so it's obviously better if the implied percentage is higher, since there's "more to contract from."
As an example of this, IBM , which announces shortly, meets the "rank test" (its rank is greater than 70), but fails the implied percentile test (<30%). It's just one of those underlyings that is never all that volatile, so I generally pass it over for premium selling.
4) Don't Force Setups. All of my short strangle/iron condored plays are set up the same way, with the short option strikes in the 80-85% probability out-of-the-money strikes. With iron condors, I can naturally fiddle with the width of my wings' spreads, but I don't monkey with tightening the short options in order to get a particular credit out of the setup. If a setup doesn't offer the credit you would like to see, pass the play over entirely.
(Continued in Part II).