Buying Options Going Long or Buying Options Going Short
Meta Pro Trader Options Education series.
Options strategies based on long positions are most effective when sharp moves are expected, or unlimited margin risk cannot be tolerated by the trader. Hedging costs are limited to the premium, so the hedger retains his ability to participate in favorable price movements.
A trader or hedger can also profit from selling, or writing, options. Just as purchasing options is similar to buying insurance, selling options resembles the function of the insurance underwriter. The options writer collects the premium and is obligated to perform should the buyer exercise his option. If the buyer does not exercise his options contract, the seller retains the premium. Because the options writers risk is potentially unlimited, short strategies that are not hedged are appropriate only for those willing and capable of assuming substantial risk.
As long as the buyer has no incentive to exercise his options contract, the writer profits. For commercial users, selling options helps offset inventory carrying costs by generating premium income. By accepting the premium, the trader augments his current income and has downside protection equal to the premium. However, he gives up the ability to participate in favorable price moves, should they occur.