Option Buying vs Option Selling: Which is Better?

Key Takeaways

• Option buying involves purchasing a call or a put option.
• Option selling involves selling a call or put option.
• In option buying, your risk is limited to the premium paid, but profit is unlimited.
• In option selling, your risk is unlimited, but profit is limited to the premium collected.

Introduction: Option Buying vs Option Selling

When it comes to option trading, one question continues to divide traders: Should you choose option buying or option selling?

Understanding both option buying and selling is crucial to participate in options trading because they significantly differ in terms of risk exposure, capital requirements and return consistency.

What is Option Buying?

Option buying involves purchasing a call option or put option with the expectation that the price of an underlying asset will move in your predicted direction.

Basically, option buying is divided into two parts: Call option buying and Put option buying.

When you buy a call option, you expect the price of the underlying asset to go up. Whereas, when you buy a Put option, you expect the price of the underlying asset to go down.

• Call option buying: Market view is bullish
• Put option buying: Market view is bearish

At the time of buying an option, you pay a premium to the option seller. The premium is your maximum possible loss for the option buyer. While doing option buying, timing, direction, and volatility are important factors to consider.

Key Features of Option Buying

• Limited Risk: The premium paid to enter the option contract is the risk, which is limited.

• Unlimited Profit Potential: If the market goes in your favour, the option premium will keep on increasing, leading to unlimited profit potential.

Example of option buying:

Suppose, nifty current market price (CMP) = 24000. Nifty 1 lot = 65 shares.

You buy a Nifty 24,100 CE at ₹100.

If Nifty CMP moves to 24,300, the option premium may rise to ₹250. So, in 1 lot, the profit is ₹250 - ₹100 = ₹150 points.

If Nifty stays below 24,100, the premium may fall to ₹0. So, in 1 lot, the loss is ₹100 points.

Basically, option buying is a low-risk, high-reward strategy but has a low probability of success.

What is Option Selling?

Option selling, also known as option writing, involves selling a Call option or a Put option in the expectation that the price of the underlying will trade sideways. However, in some cases, traders expect the price of the underlying to move in the predicted direction.

Option selling is also divided into two parts: Call option selling and Put option selling.

When selling a Call option, the market view is bearish, whereas when selling a Put option, the market view is bullish.

In option selling, you receive the option premium from the option buyer in advance, and that premium is your total profit. However, while the profit potential is limited, the risk can be unlimited.

To engage in option selling, you need to pay a higher margin to the broker, due to the risk of unlimited loss. Broker demand, the extra margin as a security deposit to cover the loss and ensure sellers fulfil their obligations.

Key Features of Option Selling

• Limited Profit: The profit is limited to the premium collected from the buyer.

• Unlimited loss: The loss can be unlimited, because if markets go against your direction, you’re bound to fulfil the contract. In this scenario, the option premium can rise sharply, which may lead to a big loss.

• Time: In option selling, time decay is a crucial factor to consider, which highly influences the price of options. If the market stays sideways, the option seller gets the benefit of time decay.

Example of option selling:

Suppose, nifty current market price (CMP) = 24000. Nifty 1 lot = 65 shares.

You buy a Nifty 24,100 CE at ₹100.

If Nifty CMP moves to 24,300, the option premium may rise to ₹250. So, in 1 lot, the loss is ₹250 - ₹100 = ₹150 points.

If Nifty stays below 24,100, the premium may fall to ₹0. So, in 1 lot, the profit is ₹100 points. (premium amount).

Difference Between Option Buying and Option Selling

The table shows the difference between option buying and option selling based on the different parameters:

When do Option Buying Strategies Work?

Option buying strategies work best when the market moves sharply either upward or downward. Since you are fighting with time decay, the move has to happen quickly.

Here are a few ideal scenarios when option buying strategies work:

1) Strong Trending Market:

When there is a clear uptrend or downtrend, option premium rises based on the direction.

2) Event-Based Move:

Events like RBI policy, Budget announcement, election results, geo-political events, can trigger big moves, favouring option buyers.

3) Low Volatility Phase:

When volatility is low, option premiums are cheaper. Therefore, buying cheap options at low IV gives better risk-reward.

4) Breakout Trading:

When the price of an asset breaks out from a key level, the option premium can move sharply in the breakout direction.

5) Momentum Trading:

When markets show strong intraday momentum, like on expiry days, option buying strategies work better.

When do Option Selling Strategies Work?

Option selling strategies work better in sideways or slow-moving markets. Option traders use non-directional trading strategies to benefit from the time decay.

Here are a few ideal scenarios when option selling strategies work:

1) Sideways Market:

When the market is stuck in a range and trading sideways, you can sell both call and put options to benefit from the decay.

2) High Volatility Phase:

When volatility is high, option premiums are expensive. Sellers benefit from selling expensive options.

3) Expiry Days:

Time decays accelerate as expiry approaches. Option sellers can capture quick premium decay on expiry days.

Option Buying vs Option Selling: Which One Should You Choose?

When it comes to option buying vs option selling, the right choice depends on your trading style, strategy, capital requirements and risk appetite.

Choose option buying if you are a beginner, have low capital, and prefer limited risk. Option buying can be highly rewarding if you can identify a strong trend reversal or breakout.

On the other hand, choose option selling if you are an experienced trader, have high capital, prefer consistent income, and are comfortable with hedging strategies.