Why retail traders typically buy options and professional trader write options

By | October 12, 2013

Regular readers of my site must be well aware of the fact, I always ask traders with small capital to stay away from Buying Options, During my trading course Typically 80% of traders have confessed , that they made there big loss when they have bought options.

Retail traders are always looking at buying options because technically you have chances of making unlimited profits with investments of small premiums, very similar to how lottery tickets work. What a retail trader forgets to look at is the fact that the odds of winning are much lower than when you are writing options. Yes when you write/sell options the profit is limited and is probably just a fraction of the margin that is blocked for writing, but the odds of winning go up significantly.

Let me elaborate with an example

Nifty is currently trading at 6100  and Trader A  buys the 6100 CE at Rs. 90  as he is bullish and Trader B who is bearish and expects the Nifty to be lower sells it at Rs. 90.

Since A is buying, so he has to pay Rs. 4500 (50 x 90) per lot to his broker and since B is writing options (around Rs 25000 is blocked as margin). A can make unlimited profits from his Rs 5000, but B can make a maximum of Rs 4500 from the Rs 25000 invested. But check out the odds and see which side you want to be on.

As i always say trading is game of Risk management and probability so lets see what is the Probability of Trader A and Trader B to make money.

For A to win at Expiry:

  • Only if Nifty is over 6190 (6100 + 90 invested into the call option)

For B to win at Expiry:

  • Nifty stays where it is due to time value erosion.
  • Nifty goes below 6100.
  • Nifty goes up but stays below 6190.

 

So Trader B  can make profits in 3 different scenarios compared to an Trader A  who can in only 1 scenario. 

As you will see the odds of a writer winning are higher.Typically Option Writers have one advantage is they do not try to time the market, During the start of series All options are having huge time value as expiry is quiet far and during the course of time if nearer the expiry comes more rapidly you will start losing the premium in Options. Thats the main reason Options Writers make huge money when Nifty remains in range and is sideways mode.

But also understand that as a writer of options you take unlimited risks and being lax on risk management would mean a severe dent to your trading account. Since you need access to higher capital for making limited returns with increased odds, option writing is what typically professionals/institutions prefer. Historically, it has also been proved that option buyers lose about 90% of the time. If you do not believe me on 31 Oct when we have the expiry see the Option Table 90% of Option will be having 0 as value. 

10 thoughts on “Why retail traders typically buy options and professional trader write options

  1. Bramesh Post author

    Thanks Vinod for your perceptive..

    Rgds,
    Bramesh

  2. Bramesh Post author

    Dear Ajay Sir,

    Am sorry for your loss, I would request learn and master the rule of the game before playing it.

    Rgds,
    Bramesh

  3. Bramesh Post author

    Thanks Hari !! I do not watch telgu movies 🙂

    Rgds,
    Bramesh

  4. hari

    Hello Brahmesh,

    What a wonderful piece of article. Good punch in the end. Just like pawan kalyan in Attarintiki daredhi.

  5. alliswell

    Fantastic post mr. Ramesh.. Great work. I tend to compare this to a casino – all retail traders (buyers) are similar to folks who play in the casino, while writers are like casion owners 🙂

    I have observed a strange scenario on oct 11th. your reasoning on why this anamoly would be extremely helpful..

    DATE: 10-OCT
    Bought 1 lot of inftec option [Strike : 3300, CALL, BUY] with option price : 115 and spot price : 3148.

    This is under the expectation that inftec would definitely move 150 points considering the strong quarter results.

    DATE: 11-OCT
    The spot price for the stock closed at 3278. Option price for 3300 call is 70.

    Since the spot price has raised and it is close to 3300 call, one would have expected the price to be higher than 115 right?

    Appreciate your response on this. Does this have any bearing on how writers influence the price of the option at a particular strike price

  6. ajay sharma

    sir i lost 4laks i option trading in 4 year now i have only 25000 thousands rs in my a/c sir what can i do to recover my loss

  7. Vinod

    Taming odds scenario….
    In specific index like nifty there is always huge liquidity, so any options buyers should prefer to buy next month series contracts / strike price options.

    Advantages
    ———–
    Very negligible time decay.
    Provides fair difference in bid and ask price as that of current month series.

    But having said this there should always be an eye on implied volatility and sideways market. But even during sideways market the premium eat away is comparatively less in next month compared to current months contracts.

  8. lakshm ramchandran

    good mrng mr. bramesh,.

    I am a regular reader of all ur posts . u are really doing a immense social education to many who blindly follow paid tips provider or free call servicepeople in facebook. thanks to u . hope I continue to learn and upgrade after reading many of ur blogs.

    have a nice day., GOD BLESS YOU.

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