Trading Option Lingo: If you buy a call, are you in the market or out of the market?
We have a communication problem when it comes options. With rare exception, when trading options on futures and stocks, people say they bought an option or they sold an option. Pretty logical, but there is a lot more to it than that. Here is why.
Let’s say I sold my cash corn, but I want to maintain a long position in the corn market. I can buy futures or I can buy call option. If corn futures go up, the call will increase in value. If futures go down and stay down, the worst that can happen to me is I lose what a paid for the call option. The buyer of an option has limited risk and unlimited profit potential. That is why they are so expensive.
After the Thanksgiving dinner, my family was talking markets. I told my siblings I bought a corn call option.
My sister said, “Well, how about that! We finally agree on which way a market is going. I bought a corn call also!”
A month later, corn futures are up 66 cents. At the Christmas dinner, I told my sister, “Our corn calls really made us some good money this past month!”
She looked at me with a bewildered look on her face and asked, “What are you talking about? I don’t have any corn calls!”
“Sis, you sat right there at Thanksgiving and told all of us you bought a corn call after I said I had bought a call.”
She put on her thinking cap and after I few seconds, she said, “Yea! I did buy a corn call, but I liquidated a short call position.”
She had bought a call to get out of the market. I bought a call to get in the market.
Months before Thanksgiving, Sis had established a market position by writing a call (sell before buying). Thus, when she bought the call a few days before Thanksgiving, she bought a call to get out of the market whereas I bought a call to get in the market. Thus, when corn futures rallied 66 cents by Christmas, she was out of the market and had no option to benefit from the rally. She had made her money before Thanksgiving when the corn price was declining. She wrote (sold before buying) a call when she thought corn futures would be headed lower in the late spring. She bought the same call at lower price after the premium declined as futures price
declined and the option lost time value.
One can buy an option to open a position and be long the market or one can buy an option to liquidate a previously established position.
Just like the futures market, for every buyer, there has to be a seller. And just like futures, one can buy an option first or sell an option first. If the option is sold first, it is not selling an option, it is writing an option.
One can buy an option to get in the market or get out of the market.
One will sell an option to get out of the market.
One will write an option to get in the market.
The seller of an option is always getting out of the market. The writer of an option is always getting in the market.
You folks who had delivery contracts that somehow doubled the bushels you had to deliver, that happened because your merchandiser wrote call options on your delivery contract. There is little doubt that he told you, but you did not understand the potential consequences.