There are strategies on whether to buy or sell in the money, at the money or out of the money options. There are questions of whether to be a buyer or seller, and to get puts or calls, and to be hedged or un-hedged. In addition, there's also the question of WHEN to select the option. Do you select short term, or long term?
There are two views
One point of view is that you believe what Warren Buffet believes, and that's that the pricing model is based too much on recent volatility, and that if you sell an option as far out in the future as possible when the volatility of the market/individual stock is at it's peak, that with all things being equal, you will probably find that the volatility won't return, and thus the buyer of the option is paying Too much. In addition, if you are Warren Buffet, you can depreciate your losses on paper, and use the sale of your options as capital to invest. If you are Warren Buffet, there's a lot more value in having cash as you can achieve greater gains with that cash.
The other view is that long term options may cost more for volatility, but paying for 1 10 month option is cheaper then 10 1 month options at the same strike price. As a result, you should own long term options, and sell short term options, perhaps even with the same stock. If you buy a long term option, and sell short term, if at any given time, the price shoots up (and you sold short term calls), you can sell your long term option to pay for your short term option, then if you wish, repurchase the long term option and continue to write short term calls. You will continue to collect the theta.
I believe what Buffet believes to a certain extent. I believe that you should be a little concerned about the implied volatility and historical volatility. If a stock has had a lot of recent volatility, you should eventually expect that volatility to decline. If that does in fact happen, it may be more difficult to sell the value in calls to get your money back, but you still should. If you do not have the ability to borrow funds at the fed funds rate, or raise capital and so on, you will be better suited buying LEAPS and selling short term. That doesn't necessarily mean both views can't be correct. You could sell puts in times of high volatility in the S&P with European style options (must be held until expiration), and make money, or you could buy leap calls in that same period of time and make money. It's even possible that you could also buy a put with the same expiration year (non European), and still sell enough short term puts to pay for it by then. I believe that buying short term options is the riskiest.
Well what if someone owns a stock and they write covered calls and the buyer actually does win. He will win more than he loses, the owner of the stock will forfeit his stock and lose a small amount, but where the heck does the money come from? The option buyer pays essentially a fee for the option, the option seller receives that fee, the option calls in the shares, and the share price is sold to someone who either paid too much for it, or someone who will eventually sell it to someone who paid too much for it. Someone will lose. However, it is possible for the option owners and option sellers to all win.
I would not want to be the one buying short term options, that requires expert knowledge about what is going to happen short term, or billions of dollars at your disposal to force the price of the stock up, and hope demand follows so you can win and still get out before people figure it out, or you could own a huge hedge fund or mutual fund and use that to try to chase a stock up higher while you sell out of that same stock. These are the kinds of games that can be played, which is why it wouldn't make sense for someone who is smart enough and can figure stuff out to turn his money over to a mutual fund manager.
So it's possible to make money as an option buyer and as a seller. The question is, does it fit with what you do, and do you know what you are doing?
There are two views
One point of view is that you believe what Warren Buffet believes, and that's that the pricing model is based too much on recent volatility, and that if you sell an option as far out in the future as possible when the volatility of the market/individual stock is at it's peak, that with all things being equal, you will probably find that the volatility won't return, and thus the buyer of the option is paying Too much. In addition, if you are Warren Buffet, you can depreciate your losses on paper, and use the sale of your options as capital to invest. If you are Warren Buffet, there's a lot more value in having cash as you can achieve greater gains with that cash.
The other view is that long term options may cost more for volatility, but paying for 1 10 month option is cheaper then 10 1 month options at the same strike price. As a result, you should own long term options, and sell short term options, perhaps even with the same stock. If you buy a long term option, and sell short term, if at any given time, the price shoots up (and you sold short term calls), you can sell your long term option to pay for your short term option, then if you wish, repurchase the long term option and continue to write short term calls. You will continue to collect the theta.
I believe what Buffet believes to a certain extent. I believe that you should be a little concerned about the implied volatility and historical volatility. If a stock has had a lot of recent volatility, you should eventually expect that volatility to decline. If that does in fact happen, it may be more difficult to sell the value in calls to get your money back, but you still should. If you do not have the ability to borrow funds at the fed funds rate, or raise capital and so on, you will be better suited buying LEAPS and selling short term. That doesn't necessarily mean both views can't be correct. You could sell puts in times of high volatility in the S&P with European style options (must be held until expiration), and make money, or you could buy leap calls in that same period of time and make money. It's even possible that you could also buy a put with the same expiration year (non European), and still sell enough short term puts to pay for it by then. I believe that buying short term options is the riskiest.
Well what if someone owns a stock and they write covered calls and the buyer actually does win. He will win more than he loses, the owner of the stock will forfeit his stock and lose a small amount, but where the heck does the money come from? The option buyer pays essentially a fee for the option, the option seller receives that fee, the option calls in the shares, and the share price is sold to someone who either paid too much for it, or someone who will eventually sell it to someone who paid too much for it. Someone will lose. However, it is possible for the option owners and option sellers to all win.
I would not want to be the one buying short term options, that requires expert knowledge about what is going to happen short term, or billions of dollars at your disposal to force the price of the stock up, and hope demand follows so you can win and still get out before people figure it out, or you could own a huge hedge fund or mutual fund and use that to try to chase a stock up higher while you sell out of that same stock. These are the kinds of games that can be played, which is why it wouldn't make sense for someone who is smart enough and can figure stuff out to turn his money over to a mutual fund manager.
So it's possible to make money as an option buyer and as a seller. The question is, does it fit with what you do, and do you know what you are doing?
About the Author:
Maclin Vestor teaches about How To Buy Stock Online. You can even learn about virtual stock markets and advice on the Stock Market For Beginners at his blog.
