Understanding Option Buying vs Option Selling Which Is Better: Out of the various derivative instruments, futures and options contracts can be traded by everyone in the market. Based on the views one has, he/she can take a long or short position in the futures contract.
When it comes to an options contract, there are 4 positions a trader can take.
- When they are bullish on the underlying asset, they can either buy a call option or sell a put option.
- When they are bearish on the underlying asset, they can buy a put option or sell a call option.
When you are provided with more than one choice to execute trades based on your views in the market, the obvious question that arises in your mind is “Which is the better position to take, buying or selling options?”
In this article, we are going to discuss Option buying vs Option selling which is better.
What Are Options Contracts?
An option is a type of derivative contract entered between two parties, whose value is derived from the value of an underlying asset. These underlying assets can be stocks, bonds, commodities, currencies, Interest rates, and market indexes.
The contracts are set to be executed on or before the specified date at a predetermined price. The parties involved in this contract are the option buyers and the option writers or sellers.
The buyers in the options contracts have the right but not an obligation to execute the options contract at the time of expiry. The option buyer will have to pay an amount called the premium to the option seller for the benefit of a choice of execution.
The sellers in the options contracts forfeit their right to execute the options contract and have to comply with the contract according to the buyers’ choice, irrespective of whether they incur a profit or a loss. For forfeiting the rights, the seller of the options contract will receive the Premium (or Fees) at the time of entering the contract.
Also Read: What Are Futures Contract? And How are they traded in India?
Option Buying vs Option Selling, Which Is Better?
Before deciding upon the better option (between buying and selling) there are various factors like intrinsic value, time decay, and volatility must be given due consideration. These factors play an important role in deciding between options Buying or Selling.
Let us understand the impact these factors have on the options contract to determine the better amongst these two alternatives.
Intrinsic value is the difference between the strike price of the underlying asset and its current market price. The closer the spot price is to the strike price, the more likely the chances of an option buyer being profitable. But the premiums paid for these strike prices will be comparatively high.
If you write an options contract for a strike price that is far away from the Spot price, there are better odds for the option seller to make money. But the premium received for selling Out of Money contracts will be less.
Volatility refers to the rate at which the price of a security will increase or decrease over a particular period. The factors that impact the volatility include economic news, political uncertainty, company performance and so on.
When there is high volatility, the underlying asset typically experiences huge price fluctuations, whereas when there is low volatility, the underlying asset typically experiences moderate price fluctuations.
If you are looking to buy Options, then ideally you should look for higher volatility as there are higher chances of options expiring In the Money(ITM).
On the other hand, you want the underlying security to have low volatility when you are writing an options contract. Low volatility in security means the likelihood of Options Expiring in the favour of the buyer is low.
It should also be noted the strike prices will trade at a high premium during the time of high volatility and at a low premium during low volatility. So the buyers will incur comparatively higher costs during high volatility and sellers will receive lower premiums during lower volatility.
The time value of an option refers to the excess amount that you pay to buy an option contract over and above the Intrinsic Value. Time value is based on the concept that an Options contract has a greater chance of being “in-the-money,” or moving in the direction the buyer wants, the further away it is from its expiration date. Time value is also known as the Extrinsic Value.
Option Premium has both Extrinsic and Intrinsic values. The further away we are from the expiry, the higher the impact of the Time factor in Option Pricing. And as we move closer to expiry, the impact of time starts reducing and we have a greater impact on Intrinsic value.
When you plan on buying an options contract, it is more favourable for the buyer if the contract has a long time until the expiration date. This is because the options with a longer expiration date have a greater chance of the underlying asset moving in the desired direction.
When you are selling an options contract, the likelihood of you being profitable increases as the options contract nears the expiration date. This is because the options with a nearer expiration date have a greater chance of expiring out of money.
It should also be noted that time is a factor that works mainly against the buyer of the option. Thus, even if you sell an options contract that has a longer timeframe for expiry, the chances of you being profitable are still pretty decent.
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Which Is Better For Trader?
Both options buying and options selling can be profitable while trading
Buyers of the Option
Sellers of the Option
The Buyers become profitable when the options become in-the-money
Sellers remain profitable when the options are out of money and at-the-money
More chances of being profitable when options have more time value
Sellers’ profits keep increasing with the decrease in time value
More chances of being profitable when the markets are volatile
More chances of being profitable when the markets are rangebound or sideways.
Before, choosing to buy or sell an traders need to understandstand the risks and benefits of both strategies.
If risk appetite risk is low or the capital available to you is low, you should be buying an options contract rather than selling an options contract. If you have enough capital available and high tolerance risk, you can go for selling an options contract.
The point one should note here is that, though the amount of risk of the buyers is limited to the premium paid by them, the chances of them being profitable are comparatively low to that of an option seller. At the same time, though the option sellers have more chances of being profitable, the losses they incur will be huge if the contract doesn’t work in their favour.
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In this article, we understood what are Options Contracts and discussed Option buying vs Option selling which is better.
Though the above-mentioned factors in this article have an impact on how the price of the options contract fluctuates, technical analysis is even more important in options trading because it tells us the direction in which the underlying asset will move. Thus, it is important to use a combination of technical analysis and the above-mentioned factors to make an informed decision while options trading.
1. How many times can i buy and sell options in a day?
There is no set limit on the number of times you can buy and sell options in a day. However, excessive trading may be subject to certain regulations and restrictions imposed by your brokerage.
2. Why option selling is better than option buying?
Option selling can be more profitable than option buying because sellers receive a premium upfront and have a higher probability of success. However, selling options comes with higher risks and requires more knowledge and experience.
3. How much money is required for option selling?
You can start options trading with less than Rs. 2 lakhs, but it’s important to trade carefully to minimize losses and maximize returns. The amount of money required for option selling will depend on individual brokerage requirements and the specific options being traded.
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