To buy an option or to short an option -- that is the question. Well, for new traders anyway. This episode of the “Ryan and Beef Show” will help you understand why we like shorting options over buying them.
Buying a Long Call
With the SPY, Ryan and Beef first look at buying a 206 call in the SPY (S&P 500) for $3.37. Buying a call option is a bullish trade, which means they want the SPY price to go higher. To buy the option, they pay a $337.00 debit (3.37 * 100 shares the option controls). For the trade to be profitable at expiration, they need the SPY to be at least $3.37 above the long call’s 206 strike price. The trade has a low probability of profit (POP), because the price of SPY needs to move a significant amount to reach $209.37.
An option’s value is derived from uncertainty around its underlying stock’s movement over a period of time. We talk about this uncertainty using the terms volatility and days to expiration (DTE). We have to pay more for options when we increase the DTE due to the increase in uncertainty. As time passes, options lose value to theta decay (all else being equal). That works against any option that we buy.
Buying Options Characteristics
- Unlimited potential profitability
- Lower probability of profit
- Theta decay (time) works against you
- Defined risk: the most you can lose is the price you pay
Selling a Short Put
When Ryan and Beef place a short put on the trade page, we can immediately see some differences. The SPY doesn’t have to go up in price for the option to be profitable, which gives us a much higher probability of profit. Instead of theta decay working against us, we collect credit each day that passes (all else being equal).
Choosing short option strategies with high POP and theta decay on our side helps us maintain consistently profitable trades.
Ryan and Beef end their segment by encouraging traders to know their probabilities to make more informed trade decisions. Understanding profitability, probabilities, theta decay, and types of risk can help us be more knowledgeable in how we go about buying and selling options.
Positives of Selling Options
- Limited profitability
- Higher probability of profit
- Theta decay works for us
- Undefined risk
Have questions about trading options? Email us at firstname.lastname@example.org.