It’s been 3 years since I got introduced to the markets. And in all this time I have constantly been reminded by all: Option Buying is a scam! A gamble!
Only people who like to burn their money get into option buying. Option Buyers are just idiots who buy a lottery in the hope of amassing great wealth.
But then, what is the truth? Is option buying actually a perilous route to eternal suffering and an abomination in the name of trading? Does it actually deserve its tag of being a bête noire that many traders abhor?
Let’s take a deep dive into it based on facts and references and hopefully clear some fog around this topic.
First of all, what is the mere purpose of Options Buying in general? (In case you are a newbie and want to learn more about Options in general here’s a great link: Zerodha Varsity: Options). Well, it was originally created as a derivative to serve as a contract based on an underlying. An option buyer generally pays some premium(which is equal to the max loss he/she/they can take) to the Option seller. If the option expires above the strike, they generally settle the shares of the respective contract and agree to sell the shares and the Option Seller takes delivery of the shares. But we won’t delve deeper into this territory as we are only concerned about Intraday/Positional trades with a disposition of squaring off the option well before expiry time.
Okay, so far so good. Then why has option buying earned itself a bad name?
It has mostly to do with the payoff graphs of both.
Well the first and foremost distinction between a buyer and a seller has more to do with PnL terms per se. An option seller has a slight advantage. An option seller even earns from theta decay, ie, premium erosion. So basically in probability terms Option sellers have a definite edge over buyers. And technically this computes to roughly 66% odds of a winning trade.
Now, even the laws of probability are against option buyer, well then how does a person even earn anything at all through option buying? The answer is the holy trinity— TIMING, POSITION SIZING AND EXIT STRATEGY. And don’t get me wrong. I am not talking about timing the markets, but timing your entry JUST RIGHT!
To be a successful option buyer, one definitely needs to work on these 3 tools. Keep sharpening these and you will be closer to your financial goals.
Now let’s talk more about the first major skill – TIMING. Why do I give this much importance to timing? The reason is as an option buyer, time is your arch rival. Your worst enemy. And that’s the reason why option sellers love time. As the expiry approaches, all the options that are OTMs give in to theta decay and lose their premiums. Well of course there are other factors as well like IV and delta. But I am talking about a normal VIX environment with less volatility. Okay, enough beating around the bush, let’s get straight to the point now. Why focus on TIMING your entries? Timing your entries right could be your edge! Yup, you heard that right. And it’s something many people ignore. Remember, markets are made up of only SMART MONEY and DUMB MONEY and that’s all there is. Side with the smart ones, jump on to the boat before it sets sail and nobody can stop you from achieving success in this business. And the only requirement for that is the grind and hustle of spotting such opportunities.