~If there is one thing we should wish for our children, it is to become an optimist. If there is one thing we should teach our children, it should be trading/investing.~
The first phrase is quoted by Daniel Kahneman, while the 2nd phrase is by me :). Trading/investing is both art and science which can benefit us whole-life if we do it correctly, be it a profession or a hobby.
In the previous post, I did mention about Buy Call or Sell Put if you aspire the stock/underlying price to increase; Buy Put or Sell Call if you own the perspective that the stock/underlying price to decrease. In this post, I will explain when we should buy or sell an options.
As an options trader, we can be an options buyer or an options seller. In order to avoid confusion, we would normally say we buy to open (BTO) a position, we sell to open (STO) a position, we buy to close (BTC) a position or we sell to close (STC) a position. Hence,
1. When we want to be an options buyer, we will BTO now and STC the position later.
2. When we want to be an options seller, we will STO now and BTC the position later.
We can be an options buyer in a trade and an options seller in another trade. These two positions can be open simultaneously and independently from each other. The next question is, when we should be an options buyer or a seller. There is no one size fits all answer. When the stock volatility is high (We can add volatility indicator to the chart to gauge the high/low volatility of the stock, this will be shown next time), it is advantage to be a seller (hope you remember the concept of reversion to mean that i explained in the previous post). In this scenario, 2 options greek, vega and theta (out of the 4 options greeks, Rho is not important hence I will ignore this Greek) will work FOR you as an options seller. Hence, in this scenario, if you view is the market will be flat or slightly bullish (stock in uptrend moving up), you can Sell to Open a PUT. If you view is the market will be flat or slightly bearish (stock in downtrend moving down, then you can Sell to Open a CALL.
When the stock volatility is low, it may not be advantages to be a options seller because of low vega. Low vega will also indirectly means lower options premium. When we are a buyer, we always want to buy low sell high and when we are a seller, we prefer to sell high first then buy low later. With a lower options premium due to low volatility, we can consider to be an options buyer. As an options buyer, we need to note two important points:-
#1, 80-90% of the options expired worthless, this means from statistical perspective, being an options buyer is not favorable as this indicates 80-90% of options buyer are losing money.
#2, as an options buyer, theta (time value) will always go against us. Even if our direction is right (we want stock/underlying to increase and it does go up), but due to the theta value decaying, we may still face a lose.
With such an unfavorable position to begin with, does it mean that we shouldn’t buy to open an options position? When we mention about Sell to Open a call or Buy to Open a Put, which strike price should we open? which Date to Expiry options should we look at? How to read an options chain? All will be revealed in the next post. Stay tune 🙂 Cheers!