The Complete Guide to Option Strategies: Advanced and Basic Strategies on Stocks, ETFs, Indexes, and Stock Indexes

CHAPTER 5

Buying versus Selling

Chapter 2 described the fundamentals of buying and selling options, but this chapter goes further, as it compares buying versus selling options, addresses probabilities, describes attributes of buying and selling an option, compares bullish versus bearish strategies, and shows how to roll from one position to another. This chapter discusses outright (single) option positions. Spreads are discussed in Chapter 6 and spread strategies are covered in Chapters 11 to 22.

OVERVIEW

Before entering into an option transaction, you should determine whether the underlying stock is likely to move higher, lower, or sideways and then select an option strategy that best matches that prediction. Because an option has a fixed expiration date, you should determine the time horizon of the move in the underlying stock as well as how far and how fast (velocity) the underlying stock will move. As a result, the best option strategy should involve a determination regarding the direction, timing, and velocity of a move in the underlying stock. In general, you would want to buy an option if you were expecting a large movement in an underlying stock or an increase in volatility, and you would want to sell an option if you were expecting movement in the stock within a range or a decline in volatility, or if you wanted to take advantage of time decay. Remember that options are commonly known as wasting assets because their extrinsic value decays over time.

A way to look ...