In the dynamic world of financial markets, investors are often faced with the pivotal decision of whether to engage in option buying or option selling. Both strategies offer unique advantages and risks, making it crucial for traders to understand the nuances before diving into the market. In this comprehensive guide, we will explore the option buying vs option selling, which is better. shedding light on which approach might be the optimal choice for your investment journey.
Option Buying VS Option Selling: Which is better?
What is Options Trading ?
Options Trading involves buying or selling contracts granting the right, but not the obligation, to buy (call option) or sell (put option) a specific asset at a predetermined price (strike price) within a set timeframe. Traders speculate on the price movement of underlying assets, such as stocks, commodities, or indices, aiming to profit from fluctuations. Options offer leverage, allowing investors to control a larger position with less capital, but they also carry risks, including potential loss of the entire investment. Strategies vary from basic directional bets to complex combinations, offering flexibility for hedging, speculation, or income generation.
Read More:
- What is Options Trading and How to do Options Trading?
- What are ITM, ATM, and OTM? and which is better?
- What Are Option Greeks In the Stock Market?
What is option buying?
Option buying involves acquiring call or put options contracts from fellow traders. When an investor opts for a call option, they buy the privilege to purchase the underlying asset at the agreed-upon strike price on or before the expiration date. Conversely, with a put option, the investor obtains the right to sell the underlying asset at the specified strike price on or before the expiration date. It’s important to note that the investor holds the right in both cases but is not obligated to execute the transaction.
What is option selling?
Option selling entails offering call or put options contracts to fellow traders. When an investor engages in selling a call option, they commit to selling the underlying asset at a predetermined price (the strike price) on or before a specified date (the expiration date). Conversely, when an investor sells a put option, they commit to buying the underlying asset at a predetermined price on or before the expiration date. It’s essential to recognize that in both scenarios, the investor is obligated to fulfill the terms of the contract if the buyer chooses to exercise their option.
Option Buying VS Option Selling
The difference between option buying and option selling is that option buying grants you the right to purchase a call or put option at a specified strike price, while option selling gives you the right to sell an option. In other words, option buyers acquire options, while option sellers sell options.
Both option buying and option selling have their advantages and disadvantages. However, according to data, in India, 95% of option buyers lose money in option trading, while only 5% of option buyers make profits. Conversely, 95% of option sellers make money, and only 5% incur losses. Despite this, 80% of traders engage in option buying, while only 20% opt for option selling.
The primary reason for the majority choosing option buying despite the higher losses is that one can start option buying with a smaller amount of money, whereas option selling requires a larger capital, often in lakhs. Therefore, professional traders predominantly do option writing or option selling, leading to the preference for option buying among 80% of individuals in India.
Factors that affect the options premium
The major factors that affect option premiums are Time decay (theta), volatility (vega), and underlying direction (delta).
Theta effect: Options buyer- enemy, Options seller- friend
An option with a longer time until expiration is considered more valuable. However, the value of the option decreases each day due to a diminishing probability of reaching the strike price – a trend that favors the option seller.
Volatility effect: Volatility factors gauge whether individuals are in a state of calm or panic. Events like quarterly results or developments specific to a particular stock often trigger panic, leading to higher implied volatility compared to historical volatility.
When implied volatility is high, option prices tend to be expensive. Conversely, when implied volatility is low, option prices are more affordable. Therefore, it’s crucial to consider implied volatility levels when deciding whether to buy or sell options. Opt for lower implied volatility when buying options and higher implied volatility when selling options.
Direction of Underlying:
When taking a position, our outlook is typically driven by a bullish or bearish sentiment. If our directional prediction is accurate, it benefits both options buyers and sellers. Conversely, if our directional forecast is incorrect, it poses challenges for both options buyers and sellers.
However, it’s crucial to recognize that the maximum loss for an options buyer is limited to the premium paid, which can go down to zero. On the other hand, for options sellers, the potential loss is theoretically unlimited, especially when an option moves significantly into the money. Therefore, the direction of the market movement plays a pivotal role, impacting the potential risks and rewards for both options buyers and sellers.
Option buying vs option selling which is better?
The choice between option buying and selling depends on various factors. If you want to earn higher returns in a short time, engage in option buying. However, if you have more capital, option selling may be the better option for you.
If you have limited funds for option trading, you can start with option buying. As your profits increase and you accumulate substantial capital, you can then consider transitioning to option selling. Many traders typically begin their option trading journey with option buying due to its lower capital requirement. Gradually, as they gain experience, some traders move on to option selling.
Deciding between option buying and selling depends on various factors:
- If you aim to generate higher returns in a short period, option buying is preferable.
- However, if you have more capital, option selling may be the better choice.
- If you have limited funds for option trading, starting with option buying is a viable approach. As profits grow and capital accumulates, you can transition to option selling.
- Many traders initiate their option trading journey with option buying due to its lower capital requirement. Gradually, as they gain experience, some venture into option selling.
- Ultimately, the decision depends on factors such as your risk tolerance, available trading capital, experience in options trading, profitability from option buying or selling, personal comfort with each strategy, and which option trading strategies prove profitable for you.
Consider whether you want to be an option buyer or seller based on your preferences and objectives in options trading.
Also read:
- What is Intraday Trading, and how does it work?
- What is Swing Trading, Strategies with Example?
- 30 Candlestick Patterns and Charts Every Trader Should Know
- Unlocking Trading Success: Mastering Support and Resistance?
Conclusion
Generally, buying options is less risky than selling them, assuming everything else is the same. Options trading has both upsides and downsides. When you buy options, your potential losses are limited, providing a clear downside. However, selling options expose traders to the risk of unlimited losses. To navigate the challenging yet potentially profitable world of options trading with confidence, it’s crucial to have a thorough understanding of these dynamics.
FAQ’s:
Which is more profitable option buying and option selling?
Option selling is more profitable between option buying and option selling because there is a higher likelihood of earning profit when selling options, while the chances of facing losses increase when buying options. However, if you trade wisely with the right strategy in option buying, you can still make a significant profit.
Do options buyers make money?
Yes, options buyers tend to make more money when market volatility works in their favor. If there is an unexpected event in the stock market, it can lead to rapid fluctuations. In such situations, option sellers may incur losses, but option buyers have the potential to earn money.
How is option selling more profitable?
Option selling is potentially more profitable as sellers receive a premium upfront, providing immediate income. If the option expires without being exercised, sellers keep the premium as profit. Additionally, time decay benefits sellers, eroding the option’s value over time. Despite these advantages, option selling involves higher risk, with potentially unlimited losses if the market moves unfavorably. Successful option selling requires adept risk management and a thorough understanding of market dynamics.
How do beginners start trading options?
Beginner options traders should start by educating themselves on options basics, including terminology and strategies. They can open a brokerage account with options trading capabilities, practice with paper trading or small positions, and gradually increase exposure as they gain experience. Seeking guidance from reputable resources or mentors can also aid in understanding risk management and strategy implementation.
Can I sell option first?
Yes, as an options trader, you can sell options first. Selling options involves writing contracts to receive a premium. This strategy can be used to profit from options expiring worthless or to generate income. However, it comes with unlimited risk if not managed properly, as options sellers may be obligated to fulfill their contractual obligations.
Why option selling is costly?
Option selling can be costly because it exposes traders to potentially unlimited risk. When selling options, traders receive a premium upfront, but they also take on the obligation to buy or sell the underlying asset at the agreed-upon price. If the market moves against them significantly, losses can far exceed the initial premium received, resulting in substantial financial liabilities.
