Buying versus selling options
Buying versus selling options: choose to buy
Yes, that is a bold statement! But this blog details the differences between buying versus selling options.
It is said that if you are on the buy side of an options trade and if it does not work in your favor then you empty what’s there in your pocket; but if you sell options and it does not work in your favor than you empty your treasury. This analogy can be applied towards the topic of buying versus selling options.
Here are some advantages of buying versus selling options.
1st advantage of buying versus selling options is demonstrated through this example. Say we buy a Nifty option of Rs. 100, we have to pay just the premium of the same which is 5,000 (50*100) and if we sell the same option we have to pay a deposit of around 25,000 which is requirement by the exchange itself.
2nd advantage of buying versus selling options is shown through this example. We will take a longer period of time, say 12 months ,as it is always wise to take a longer period into count. We buy a out of money (OTM) option at say Rs. 10 Worst case, you will lose 5,000 in case it expires on the last day and does not increase. You will definitely be loosing 50,000 for 10 months cause no one can earn all the months, but remaining 2 months that Rs. 10 can become 100, so those 2 months you will earn 500*90*2(quantity* profit* months) which is 90,000. 90,000 minus which we lost was 50,000. So, in our example we earn net of Rs. 40,000.
Now you will wonder how will an option of Rs. 10 become Rs. 100. This will definitely happen as Indian markets are very volatile and politics has a greater impact on our market and we will have 3-4 months of volatile trading in a year. So, you will see a sudden hikes in prices of options, either down or up. So, if you are in buying side, you will get a chance to earn once in a year and it will earn a net profit for you for the whole year. Basically, you should know how to churn the buying of options, buying at correct time and selling the same and again re-entering the trade again.
Exactly opposite happens in selling of options. You will earn 10 months and will loose more than the earned in remaining 2 months. In our above example you will loose net 40,000. Apart from loosing, your broker will continuously ask you to pump in funds to cover your daily MTM losses, failing to which he will square all your positions. No one will be happy to earn 10 months and lose more than that in that remaining 2 months.
Basically, buying options means you know your losses are fixed and the buying of options is more profitable when you properly determine the entry point and you buy it before the implied volatility increases.
Selling of options is risky because you do not know your loss. Selling of options is definitely helpful for traders who can continuous pump in money to cover the MTM losses (if any) and the extra margin been charged day by day and it can work wonders for them as selling of options is just done because of time decay of options.
Buying is the best option against selling for traders with minimum capital and less risk appetite.
When given an option to buy or sell an option, I advise you to buy!