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.