Buying vs. Selling Options
There are many ways to profit trading options. The two most common strategies investors use are to buy or sell options. This lesson highlights the difference between buying vs. selling options by focusing on how the direction of the stock affects each strategy.
2 Stock Directions
Stocks are fairly easy to understand. They have two directions for you to think about, up and down.
If you buy a stock and it rises, then you can sell it to make a profit.
Likewise, you can sell a stock (or short sell), then buy it back when the price declines to save yourself money (make a profit).
Options are a bit different.
3 Options Directions
While up and down also exists with options, there’s a third "direction" - stays the same, or no direction.
Yes, in options no direction is a direction. In fact, it's possible to use options and profit when the stock:
- Goes up;
- Goes down; or,
- Stays the same.
These 3 "directions" play a significant roll when you compare buying vs. selling options. Option Buyers generally profit with larger price moves. Option Sellers are looking for just the opposite. They profit the most if the stock doesn't move!
Buying vs. Selling Options
The diagram above shows the 3 possible directions a stock can go when trading a Call Option.
Notice that Call Option Buyers mainly profit in 1 of the 3 possible outcomes, up. On the other hand, Call Option Sellers profit in 2 of the 3 possible outcomes. They profit if the stock stays the same or the stock declines.
Profiting with two of the three directions, along with accepting the premium upfront, plays a large part in the allure of selling options.
Unfortunately, Options Sellers must fully understand the risk they inherit.
Is Selling Options Better?
Listen very clearly, there is no “Free Lunch” when trading options.
Just because an Option Seller has two ways to win, does not mean that selling options is a better strategy. Let me be very clear, investors can make money buying options or selling them.
What's most important is that you understand the risk-reward balancing act between buying versus selling options.
In general, selling options wins more than buying options. However, the profits are relatively small with each win. And when you lose, the losses are relatively larger. In some cases, the losses can be significant, or even catastrophic.
On the contrary, buying options is limited to the amount invested. This means you lose relatively smaller amounts more often; however, when you win, the profits could be significant.
Who Buys Options?
If you look online, most online options "gurus" advise you to sell options.
I think you might find it interesting that the top and most well-known Hedge Fund Managers like Steve Cohen, Dan Loeb, Bill Ackman, Carl Icahn, and George Soros, just to name a few, BUY OPTIONS.
And the reason they buy options is because it allows them to invest smaller amounts of capital to potentially make significant profits.
Did you know that the biggest trade in Wall Street history was an options trade?
The Top 1% bought hundreds of millions of dollars in bond options ahead of the housing market crash. Several of the Top 1% turned a few million dollars into profits exceeding a billion dollars. Hedge Fund Manager John Paulson personally made over $15 Billion dollars.
The question becomes: “How do they Buy Options to gain an advantage?”
Answering this questions is at the heart of what makes 3 Steps to Profit the Best Options Trading Course on the market.