By Andy Jordan on Thursday, 12 May 2016
Category: Trading General

Thoughts about being an option buyer

An option buyer has the odds strongly stacked against him. What most option buyers don't realize is that in order for them to make money, they must be right in three areas:

  1. He has to be right about market direction

  2. He has to be right about the degree of market direction

  3. He has to know when the market move will move in a certain direction

That is definitely worse than being a trader in the underlying. There’s one simple question. If you can accurately and consistently determine market direction, the degree the market is going to move in that direction, and when it will move within a specified time period, why do you need to concern yourself with buying options? On the other hand, if you can't consistently do those three things then you are going to consistently lose your money buying options.

There are four losing scenarios for option buyers:

  1. If the market moves against you by expiration, you lose.

  2. If the market goes nowhere by expiration, you lose.

  3. If the market moves in your direction, but not in the amount needed to move past the strike price PLUS the price you paid for the option, you lose.

  4. If the market moves in the right direction by the minimum amount needed, but not within the time period, you lose.

While the amount you lose is limited to the option price, the probability of you losing it is extremely high.

That's why we usually don't buy options in Traders Notebook – we sell them. Selling options can bring in some consistent profits if done the correct way. We prefer to sell far out of the money options with a low delta and instead of selling naked we prefer to sell Spreads or Iron Condors. Hedging our position brings down the margin to a minimum and we do not need huge trading accounts. Many of our subscribers trade with only $10k to $20k.

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