Reasons 1-3 and 4-6 below look correct. Is the author's conclusion correct though?
To make a profit on the buying side:
- You have to be directionally correct. The price must go up for calls, down for puts.
- AND the share price move must be bigger than the premium you paid.
- AND the share price move must happen before the option expiration.
You will notice that it is pretty unforgiving. Sure, when you are right, you can make a 100% to 1000% profit in a few months, weeks, or even days. But there is a big chance that you will suffer death by thousands of cuts with your long call or put contracts losing value every day and become worthless.
We were discussing earlier how volatile stocks can have a high extrinsic value. What happens to your option price if the share is changing a lot and suddenly calms down? The extrinsic portion of the option price will crater quickly because volatility dropped, and time is still passing every day.
The same way you can buy options, you can also sell call and put options. Instead of buying the right to exercise your ITM calls and puts, you sell that right to a 3rd party (usually market makers).
To make a profit on the selling side:
- You have to be directionally correct.
- OR the share price does not move as much as the premium.
- OR the share price does not move before the option expiration.
Buying calls and puts mean that you need to have strong convictions on the share’s direction. I know that I am not good at predicting the future. However, I do believe in reversion to the mean (especially in this market :)), and I like to be paid as time is passing. In case you didn't guess yet, yes, I mostly sell options, I don’t buy them. This is a different risk, instead of death by a thousand cuts, a single trade can have a big loss, so proper contract sizing is really important.
It is worth noting that because you sold the right of exercise to a 3rd party, they can exercise at any time the option is ITM. When one party exercises, the broker randomly picks one of the option sellers and exercises the contract there. When you are on the receiving end of the exercise, it is called an assignment. As indicated earlier, for most parts, you will not be getting assigned on your short options as long as there is some extrinsic value left (because it is more profitable to sell the option than exercising it). Deep ITM options are more at risk, due to the sometimes inexistent extrinsic value. Also, the options just before the ex-dividend date when the dividend is as bigger than the extrinsic value are at risk, as it is a good way to get the dividend for a smaller cash outlay with little risk.