selling CALLS vs. buying PUTS
- Thread starter jimclark
- Start date
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I had a similar question before and the best explanation i got was recently after having read the Market Wizards by Jack Schwager (a must read for every aspiring trader IMHO) at the appendix it states:
"Whereas the buyer of a call or put has limited risk and unlimited potential gain, the reverse is true for the seller. The option seller (often called the writer) receives the dollar value of the premium in return for undertaking the obligation to assume an opposite position at the strike price if an option is exercised."
"Some novices have trouble understanding why a trader would not always prefer the buy side of the option (call or put, depending on market opinion), since such a trade has unlimited potential and limited risk. Such confusion reflects the failure to take probability into account. Although the option seller's theoretical risk is unlimited, the price levels that have the greatest probability of occurrence (i.e., prices in the vicinity of the market price when the option trade occurs) would result in a net gain to the option seller. Roughly speaking, the option buyer accepts a large probability of a small loss in return for a small probability of a large gain, whereas the option seller accepts a small probability of a large loss in exchange for a large probability of a small gain. In an efficient market, neither the consistent option buyer nor the consistent option seller should have any significant advantage over the long run."
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I think that clearly explains the difference as at first it seems suicide to sell calls because of the unlimited risk (same as shorting a stock outright)and limited profit potential. But as one learns to think in probabilities, it doesn't seem so bad. In any event, some form of risk management must be in place so assuming the stock did go against you a certain amount you should cut your losses short. Again, easier said than done.
And if it doesn't sit still or if it moves quickly or if vol goes up then the long option can be the winner.
Unfortunately everything in trading is 'IF'.
So we're back again at square one: there is no advantage of selling over buying. This topic has been thrashed to death on this forum. Hopefully it can finally rest in peace
db
Quote from daddy'sboy:
And if it doesn't sit still or if it moves quickly or if vol goes up then the long option can be the winner.
Unfortunately everything in trading is 'IF'.
So we're back again at square one: there is no advantage of selling over buying. This topic has been thrashed to death on this forum. Hopefully it can finally rest in peace
db
"So we're back again at square one: there is no advantage of selling over buying. This topic has been thrashed to death on this forum. Hopefully it can finally rest in peace "
this topic does not rest because of comments like above.
if you want be be in the insurance business you sell options and collect your premium.
if you are in the insurance business better make sure that you are selling options on a diversified portfolio.
if you are in the insurance business ie selling options remember you are competing against professionals with arsenals of computers who like insurance companies know how to hedge their exposure to reduce their risks.
most posters on ET make directional bets. therefore they should not be selling naked options which by definition offer returns limited to the premium received.
Hi zdreg
Thanks for your feedback.
I think I probably didn't express myself clearly enough so I'll try again.
There is no advantage in selling over buying options (see above quote). Period.
This assumes that the trader knows what he's doing. Iow a good trader will make money whether he buys or sells options. I work both sides but I'm NEVER short naked options.
Cheers
db