Options trading is like playing chess, but with money instead of pieces.”
Options are a popular financial instrument used for hedging, speculation, and income generation. Options trading involves two parties, the buyer and the seller, who have different objectives and risks associated with their positions.
Buying options and selling options are two different strategies in options trading. While buying options is a popular strategy used by traders to make speculative bets on the price movement of an underlying asset, selling options can be used to generate income by collecting premiums from options buyers.
Who will win between Option Buyer and Option Seller?
The answer to who will win between option buyer and option seller depends on several factors such as market conditions, the strike price, time to expiration, and the volatility of the underlying asset.
In general, the option buyer is looking to profit from a move in the price of the underlying asset, while the option seller is looking to profit from the premium collected from selling the option.
Here is a table outlining the factors that may influence who wins in the options market between a buyer and a seller.
Option Buyer Wins
Option Seller Wins
Buyer profits if the market moves in their favor
Seller profits if the market stays stagnant or moves against the buyer
Seller profits as options decay in value over time
Buyer loses as options decay in value over time
Buyer profits if implied volatility increases, making their option more valuable
Seller profits if implied volatility decreases, making their option less valuable
Buyer has potentially unlimited profit potential
Seller has limited profit potential (to the premium they receive)
Buyer has limited risk (to the premium they pay)
Seller has potentially unlimited risk
It’s important to note that the factors above do not guarantee a win for either party. Both buyers and sellers take on risks when trading options and must understand the potential outcomes before entering into any trades. Ultimately, the winner in any option trade will depend on market conditions and the specific details of the trade itself.
Advantages and Disadvantages of Buying Options:
Buying options can be a useful strategy for traders and investors to gain exposure to the underlying asset while limiting potential losses.
Limited Risk: Buying options provides a capped downside risk, as the most that can be lost is the premium paid for the option.
Higher Costs: Buying options can be expensive, as options premiums tend to be higher than the cost of buying or selling the underlying asset.
Leverage: Buying options allows for the potential to gain significant profits relative to the amount of capital invested.
Time Decay: Options have a finite lifespan and lose value over time due to time decay. This means that options buyers need to be correct about the direction of the underlying asset’s movement within a specific timeframe to realize profits.
Flexibility: Options buyers can choose from a range of strike prices and expiration dates to suit their trading strategy and market outlook.
Limited Profit Potential: Buying options has a limited profit potential, as the most that can be gained is the difference between the strike price and the underlying asset price at expiration, minus the premium paid for the option.
Hedging: Buying options can be used to hedge against potential losses in a long or short position in the underlying asset.
Requires Market Movement: Options buyers need the underlying asset price to move in the desired direction to realize profits, which can be challenging in a stagnant or volatile market.
It is important to have a clear trading plan and risk management strategy when buying options.
Advantages and Disadvantages of Selling Options:
Selling options can be a lucrative strategy for experienced traders, but it also comes with its own set of advantages and disadvantages. Here are some key points to consider:
Option sellers can earn income from the premiums they receive when selling options.
Selling options can provide traders with more flexibility in their overall strategy, as they can use options to hedge their positions or generate additional income.
Options sellers can take advantage of time decay, as the value of an option decreases over time.
Option sellers are exposed to unlimited risk if the underlying asset moves against them in a significant way.
Selling options requires a higher level of experience and knowledge compared to buying options, as it involves more complex strategies and calculations.
There is always a possibility of an unexpected market event or volatility spike, which can result in significant losses for option sellers.
Here is a table summarizing the advantages and disadvantages of selling options:
Earn income from premiums
Unlimited risk if underlying asset moves against the seller
More flexibility in overall strategy
Requires higher level of experience and knowledge
Take advantage of time decay
Possibility of unexpected market events or volatility spikes
Different Studies on Option Buyer Vs. Option Seller:
There have been various studies conducted to determine whether option buyers or option sellers make more money. Let’s take a look at some of these studies:
A study by The Journal of Finance found that selling options can be more profitable than buying options. The study analyzed data from 1986 to 2006 and found that selling options produced higher returns with lower risk than buying options. Link: https://onlinelibrary.wiley.com/doi/full/10.1111/jofi.12347
A study by the University of Illinois at Urbana-Champaign found that selling options can be more profitable than buying options. The study analyzed data from 1996 to 2009 and found that selling options produced higher returns with lower risk than buying options. Link: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2109484
Here are some similar studies on with data points on Indian Share Market –
“A Comparative Study of Option Buying and Option Selling Strategies in Indian Stock Market” by J. Jaya and Dr. R. Vijayalakshmi. This study analyzed the performance of option buying and option selling strategies in the Indian stock market from 2005 to 2010. The results showed that option selling strategies outperformed option buying strategies in terms of profitability and risk management. (Link:http://www.ijbmi.org/papers/Vol(3)10/Version-3/I031035238.pdf)
“A Comparative Study of Option Buying and Option Selling Strategies in Indian Stock Market” by Shashikant N. Kulkarni and Dr. Vijaykumar M. Biradar. This study analyzed the performance of option buying and option selling strategies in the Indian stock market from 2010 to 2015. The results showed that option selling strategies outperformed option buying strategies in terms of profitability and risk management. (Link: http://www.ijsrp.org/research-paper-1115/ijsrp-p4769.pdf)