Are You a Buyer or a Seller?
The question is: which is better, selling volatility or buying volatility? I
have attended option seminars with instructors (many of whom I regard
with great respect) teaching that volatility-selling strategies, or income-
generating strategies, are superior to buying options. I also know option
gurus that tout the superiority of buying options. The answer to the question
of which is better is simple: it’s all a matter of personal preference.
When I began trading on the floor of Chicago Board Options Exchange
(CBOE) in the 1990s, I quickly became aware of a dichotomy among my
market-making peers. Those making markets on the floor of the exchange at
that time were divided into two groups: teenie buyers and teenie sellers.
Teenie Buyers
Before options traded in decimals (dollars and cents) like they do today, the
lowest price increment in which an option could be traded was one
sixteenth of a dollar—a teenie . Teenie buyers were market makers who
would buy back OTM options at one sixteenth to eliminate short positions.
They would sometimes even initiate long OTM option positions at a teenie,
too. The focus of the teenie-buyer school of thought was the fact that long
options have unlimited reward, while short options have unlimited risk. An
option purchased so far OTM that it was offered at one sixteenth is unlikely
to end up profitable, but it’s an inexpensive lottery ticket. At worst, the
trader can only lose a teenie. Teenie buyers felt being short OTM options
that could be closed by paying a sixteenth was an unreasonable risk.
Teenie Sellers
Teenie sellers, however, focused on the fact that options offered at one
sixteenth were far enough OTM that they were very likely to expire
worthless. This appears to be free money, unless the unexpected occurs, in
which case potential losses can be unlimited. Teenie sellers would routinely
save themselves $6.25 (one sixteenth of a dollar per contract representing
100 shares) by selling their long OTMs at a teenie to close the position.
They sometimes would even initiate short OTM contracts at one sixteenth.