Buying options can be as simple as buying a long call, but in general the term includes anything that is long delta, short theta and can be thought of as the entire basket of strategies that fit into this category.
Selling options tend to be positive theta, and have certain characteristics. There are dozens of options strategies that traders use. But, let’s keep the term ‘buy’ and ‘sell’ as the split in philosophy from the trader.
For the simplest answer, buyers are less consistently profitable, but can make more money when they’re right, and have fixed risk from the sizing of the trade. Sellers are more consistently profitable, but will make less profit when they’re right and lose more when they’re wrong.
The risk in buying is that you don’t hit your directional moves often enough, and your profits are too inconsistent, leading to a poorly performing account. The risks in selling are that when you’re wrong, you give back all of your profits in short bursts, and these draw downs can hurt your account, your psyche and your trading badly.
For context on those terms, and what I mean, consider watching this 17 minute YouTube video I recorded a few years ago, as I answered a similar portfolio question from one of my students:
Options portfolio’s can be simple, they can be complex, and they can be built anywhere in between the ‘sell’ side and ‘buy’ side strategies.
In my experience, sell side option traders are more likely to build consistent profitability. Buy side option traders are more likely to struggle and be inconsistent.
But, there’s a catch in there. Selling options tends to be lower reward, higher probability and higher risk when you analyze the single position in the trade. Consider 2 hypothetical trades:
Trade 1: Trader sells -1 Put option, receives $100 premium, has an 80% probability of keeping all of the premium at expiration (maximum profit) but carries $300 Risk.
or
Trade 2: Trader buys 1 call option, pays $100 premium, has a 40% probability of the trade building a profit with a target of $200 reward.
Which trade is better?
In trade 1, your Reward to Risk Ratio is $100 potential Profit /$300 potential risk.
And in trade 2 your reward to risk ratio is $200 potential profit /$100 potential risk.
If I considered trading this strategy 100 times, and assumed the math would be the same on each trade, then trade 1 would produce 80 wins x $100 = $8000 and 20 losses x $300 = -$6000. The net result of $8000 – $6000 = $2000 profit expectancy.
After 100 total trades, trader 1 leaves with $2000 total profit.
Modeling out trade 2 over 100 times, the assumed win rate of 40% would net 40 wins and 60 losses. 40 x $200 = $8000 profit and 60 x 100 = -$6000 losses. This would net a profit expectation of $2000 total (8k – 6k).
After 100 total trades, trader 2 leaves with $2000 total profit.
Which is better? Well, in these examples, the net profit is the same, but the ride a trader goes on is a very different experience. Trader 1 will win most of the time, but have to deal with larger losses, and the emotions of watching a few trades hurt their account badly. These are consistent with sell side options strategies.
Trader 2 will not have profits as often, but the potential for bigger wins and smaller losses keeps the per trade risk low, but you sacrifice consistency.
This is essentially what you face when you buy and/or sell options. In trading, you should learn how to do both, and how both will fit in the larger context of your trading business or portfolio design.
But, when you’re actually trading, you have to think about how that 1 trade fits into the larger context of where implied volatility is moving, what the expectation of the market is going to be and also how your position fits into your larger portfolio design.
There are lots of tutorials on our YouTube channel, to better understand options: Tackle Trading