What Is the Difference Between an Option Buyer and an Option Seller? Part 1

What Is the Difference Between an Option Buyer and an Option Seller

? Part 1

If you ever wondered how options works, it can be summed up as follow:

A buyer of a call option hopes that the security from where the option derives, is going to move up. That means that the stock or commodity that your options derive from - also known as underlying security - will move up. So, the buyer of this option has the right to control a bullish directional position of X number shares of the stock for a pre-determined period of time (since all options have expiration dates, ones are longer others shorter). Of course that comes with a price which is referred as "premium" that usually costs less than the security itself. As for commodities, it pretty much works the same way, only this time you have the control over a future contract also for a specified period of time and a specified strike prices. Both the strike price and the expiration date are known beforehand, you never buy an option without knowing when it will expire and how much is the strike price. The buyer has no obligation whatsoever to exercise and buy the underlying stock/commodity. But the seller, in other hand, has the OBLIGATION to sell it. So, there is limited loss potential - the price paid for the option - but it has an uncapped profit potential.

It does look great doesn't? Who wouldn't want a trade that has unlimited profit potential and limited loss potential? But, as you probably know it, it is not as easy as 1-2-3. You always have to consider several other infos to properly conduct your trade. For example, how much money should you put in this trade alone? Just a quick example of what could happen if you didn't pay attention to position sizing in your trade:

Say you put 90% of your equity in one trade and the remaining 10% in some other trade. Then, the latter goes up and make a 100% profit! G R E A T! But, the other trade went bust and you lost 20% of your initial money on the trade. The end result would have been that you LOST money even though you had one trade that made 100% profit.

So, just pay attention to position sizing as well when deciding which trades you are going to make.

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