Options trading is a specific type of trading that is best executed once you have a solid understanding of the vacillating variables that drive the market. This is the main thing to consider before entering this type of trading. While some consider options as a separate asset class, many analysts and experts, including us, believe it is a trading instrument. Buying options vs selling options unravels a whole range of discussions, which is what we’ll be exploring in greater detail today.
The reason is that stocks, forex, commodities and cryptocurrencies have their own market and value derived from specific variables. If you’re looking to trade forex as a beginner and weigh up the benefits and disadvantages of forex and stock trading, options will likely enter the discussion at some point. Options trading is a specific tool that traders utilise within these markets. They use it to take advantage of the market sentiment and market climate at that time.
Whilst you do not need to know how buying and selling options work to trade assets such as forex successfully, knowing about as many instruments as possible is beneficial. Traders use a wide variety of instruments, so it is advantageous for you to be aware. When we say traders, we don’t just mean retail investors. We are referring to institutional investors, too, such as large investment banks and hedge funds.
What Are Options?
It’s best to define options clearly before we dissect the advantages and disadvantages of buying and selling via this instrument. An options trader is known as a “speculative” trader. Their main skill is identifying the market sentiment direction and which way it could move.
Whilst this is the goal for all traders, options trading works differently as they openly execute their position based on the asset’s price at a future date. This will be specified within the options contract, and the contract doesn’t mean you are obligated to purchase. It means the choice is available to you.
Standard spot trading works differently, as you can buy and sell your position on the market based on current prices. An example of this would be day trading. Options are contingent on a precise price on a certain date. So when it comes to buying vs selling options, this is one of the main differences.
Advantages Of Buying Options
When you buy options and trade via this instrument, you are utilising the power of leverage. This can pay off, but it can also work against you more negatively than a simple buy-and-sell trade. The main advantage is that you can profit more using smaller capital.
The flexibility of having no obligation to buy the contract gives you options. As long as you continue to pay the premium to keep the option valid, you could earn a huge profit by continuing to honour the premium.
Disadvantages of Buying Options vs Selling Options
One of the main downsides of buying options is that there are usually high levels of commission. As we have detailed above, one advantage is being able to keep a large position open by paying the premium. However, by the same token, if you cannot pay the premium continually, your position will be liquidated.
When entering any trade, be it buying options vs selling options or otherwise, you must ensure that you fully understand the market you are entering. This can be a recipe for disaster if you are entering a position you don’t fully understand, as you can stand to lose substantial amounts of cash.
Advantages of Selling Options
Selling options vs buying options is a discussion that rages on between traders. Selling options work differently as the premium we discussed in buying options is obtained straight away. It is a crucial difference to acknowledge as you are then allocated the obligation to execute your sale. This contrasts buying options vs selling options as you earmark a future date to perform your sale.
Two key methods facilitate buying options vs selling options. When exploring the selling vs buying options, these two choices are calls or puts. A call is an effective option if a trader is looking to protect an investment over a longer period from short-term volatility which causes the asset price to decrease.
Examples of Selling Options
Once this position is called upon, the premium paid is defined as profit. Traditionally, this options trading method is better suited to a market that is suited for a market downturn (bear market), and you’re more likely to see it in equities markets.
The second type of sell option is a put option. A put option indicates that the speculative method of trading the investor has settled on as their course of action is pointing towards a bullish position. The agreed contract constitutes an obligation for the trader to obtain the asset at the prearranged, specified price. If the value of the investment maintains an average level above the agreed level, the agreement lapses and then the premium turns into realised profits.
The buy vs sell options and put options inter-relationship consists of minor variations. Selling can be a fruitful endeavour. Puts and buying calls allow the trader to gain quick access to live market conditions straight away.
Disadvantages of Selling Options
As we have already found out in today’s piece, selling vs buying options throw up an assortment of talking points. There are several advantages of selling options, but on the contrary, we will divulge a few negatives. This is so you have a full scope of what buying options vs selling options entails and whether or not it is something you could see yourself getting involved in at some point.
Theoretically, you could lose an unlimited amount whilst living in this position. Clearly, this is a serious downside and one that you must weigh up. In addition, there’s lower liquidity, and you can suffer more due to higher levels of volatility. There are fine margins for this type of trading, and you must consider them all.
General Rules to Remember
Although we have dissected selling vs buying options today, there are more general rules to consider when entering a trade.
Don’t Trade On Emotion
The most important rule to remember is to never trade on negative emotions. This is a bad idea if you find yourself trying to recoup losses in the market with no strategy. If you are not spending time researching your position or getting to know the asset well enough to decipher its chart analysis, this is a recipe for trouble.
Whilst trading on emotion can be advantageous if you know how to harness it into an effective strategy, it can also cause you to lose money. Whilst you can still lose all your money despite performing all of this effective due diligence, you have a better chance of making a successful trade if you keep your negative emotions at the door.
This is why many experts, analysts and professional traders use automated software to buy and sell their orders automatically. Some traders and people in the industry also referred to it as algorithmic trading.
Carry Out Effective Research
We touched on this briefly in the last section; whilst “effective research” may sound like a general soundbite that traders use, it is extremely important. This can encompass a number of things, such as:
You can implement chart analysis over several different periods. For instance, sometimes it can be a short-term analysis (between 15 minutes to 24 hours) if you are looking to day trade forex. However, if you are looking for a long-term strategy, check a long-term chart that covers a period between 24 hours and 1 month or 1 year. However, it is smart to check the whole range. Irrespective of the type of trade you want to execute, you want to have a broader picture of your position in the market.
Current or Future News That Drives The Price
If you are looking to trade a company’s stock, make sure you are looking at any recent press releases. This is a good starting point, but also make sure you’re checking stories in the media. For example, if there was news about any big future developments. Applying this theory to foreign currency exchanges is also beneficial. News regarding foreign currency would focus on economic policy and any news regarding the economy as a whole.
Historical Data & News
As well as chart analysis, you can look at what has historically driven the asset price. One example of this could be the Tesla price, which has grown enormously since the beginning of the last decade. However, it has been subject to some fairly volatile fluctuations due to instances involving its CEO Elon Musk. An appearance on Joe Rogan’s podcast caused the Tesla stock to drop by 9% in one day. His erratic behaviour has also played out on Twitter, where some tweets were brought into scrutiny, worrying shareholders and investors.
He has since gone on to purchase the social media giant. However, will stretching his availability between two of the biggest companies in the world mean they both suffer? This speculation has seen Tesla’s share price drop as concerns over whether Musk can juggle two of the biggest companies in the world at the same time. However, whilst some analysts predict the Tesla price would correct anyway due to the 15,000% increase since 2010, Musk has an army of loyal fans who believe wholeheartedly in his business models and strategies.
Ensuring you consider all of these things before weighing up buying options vs selling options is a highly advisable route. You must understand how options trading works, as it isn’t usually the first type of trading somebody will embark upon. It is ideal that you learn the basics of the market and how buying options vs selling options work before looking to trade via either of these instruments.
Whilst there is potential for great returns with this type of trading, there are also great risks. Hopefully, we have informed you enough today so that you can take this knowledge and apply it to your trades. It will ensure that your strategy is more well-rounded moving forwards. Much like any trading method, there are pros and cons. It takes a layered approach to reach the other side of the trade in a better financial position than the one you started in. Invest with caution, and become familiar with the basics. This sets the solid groundwork for your trading strategy in the future.