Forget the Usual Advice About Options

I recently read a blog comment stating the usual advice about options trading, that "selling options is risky, but buying options is safe". This is the popular opinion about options trading, and as is usually the case with popular opinion, it is wrong.

This advice is based upon the risk and reward of the basic options trades, which state that long options trades (i.e. buying options) can make an unlimited profit, but can only lose the options premium, while short options trades (i.e. selling options) can only make the options premium, but can lose an unlimited amount. This is technically correct, but only if you trade options like an amateu ... ahem, I mean like a buy and hold trader.

The reality of options trading is that long options trades (i.e. buying options) immediately lose money (by paying the options premium), and then spend the entire trade trying to make it back to break even (let alone make a profit). Conversely, short options trades (i.e. selling options) immediately make money (by receiving the options premium), and then spend the entire trade waiting, in profit. If you had two choices to make, one of which would immediately lose money, and the other of which would immediately make money, which one would you choose? Well, the same common sense applies to options trading.

Fine, but even if short options trades are the more profitable options trades, how do you overcome the problem of the unlimited risk? Well, very easily actually, by exiting the trade. For some reason many options traders believe that options trades must be held until they expire, but this is completely false. Options trades can be exited at any time simply by trading the same option in the other direction. If you were long an option, you would sell the same option to exit the trade, and if you were short an option, you would buy the same option to exit the trade. If you were in a short options trade and the underlying market moved against your trade, you would exit the trade, thereby taking only a small loss instead of the supposed unlimited loss.

So, short options trades have a significant advantage over long options trades in that they are immediately in profit as soon as the trade is entered. The potential unlimited risk of short options trades can also be removed simply by exiting the trade at any time. With this in mind, it is clear that the usual advice about options trading is wrong, and this is why professional options traders prefer short options trades, and why many of them trade short options trades exclusively.

If you are not yet convinced, try this. I am not aware of any options traders that make money trading long options trades, but I am aware of options traders that make money trading short options trades. Enough said?