Monday, March 26, 2012

Is It Better To Buy Or Sell Options?

This is the question perpetually asked by retail option traders, often having been tainted by BS from some hyped up moron on a stage. I guess the question in their mind is over the long term,whether the negative theta of long options is too costly to be overcome by the long gamma and therefore it is better to sell options and take the other side of the equation.

In this simplest form it ignores volatility and presupposes that one should 'always' be either a seller or a buyer.

Professionals rightly point out that if options are correctly priced, there is no long term advantage in either buying or selling options. In my experience as a retail trader of some length of time, I am quite prepared to accept that as broadly true.

However, most retail traders, seem to fall on the side of selling options, or rather being nett short premium and short gamma at inception at least. Certainly a short gamma strategy where the short strike(s) are somewhat out of the money will have a higher than 50% win rate, which makes it 'feel' like it's a better way to go. However the win rate is irrelevant if the relatively fewer but higher losses, outweigh the more numerous but smaller wins.

Sometimes it can take neophyte option traders some time and a bend at the end of the trend to realize this.

Perhaps the most absurd reason I have seen is the claim that "80% of all options expire worthless", so it is much better to sell than to buy. Apart from this being at worst complete bollocks and at best a misrepresentation, it is irrelevant as discussed above. The actual figures I will detail in another post, but let's put our thinking caps on here.

Supposing XYZ is trading at $50 and I sell a $40 put, is there an 80% chance of the put expiring worthless? That's entirely possible, but what if I sold the call instead? Is there also an 80% chance of the call expiring worthless?

 Of course not.

What if I sell the ATM $50 put or call? There would be about a 50% chance wouldn't there? I could belabour this point further, but you get the point that chance of expiring worthless is dependent on several factors.

The question of whether to be a buyer or seller, if the question is couched in terms of always being a buyer or a seller, is the wrong question in my view. It is often asked because neophytes fall in love with a particular strategy and try to impose it onto every market condition. An example of this are the traders that have been sold a course on bull put spreads or covered calls and try to trade that strategy at all times. Real life invariably teaches these people that these strategies, though perfectly good strategies when appropriate, do not fit every market condition.

The question I want to ask is - What is the best strategy right now, at this point in time, for this particular market?

Before that can be answered, one must have a view of direction, volatility and the possible magnitude of changes in these. An understanding of how it might be if it blows up in your face is also essential.

Therefore the answer to the question posed is - it depends.


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  3. It's not an easy question. Sometimes it's better to sell options and something it's better to buy them. The key is getting the direction right. (I use Horseshoe Trades for help on picking the right stock). Then it doesn't matter if I buy or sell calls or puts because it you're right in direction you'll make money.

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