Insights

Options – Buying vs Selling

August 26, 2020 . Perumal Raja

In this article, we will guide you on when one should be buying options or selling options.

What are the factors that affect the option price? Well, there are 3 key factors which affect the option price 

1. Volatility (Vega)
2. Time value (Theta).
3. Change in option premium with respect to change in the underlying asset (Delta)
 
The main difference between Buying Options vs Selling Options.

When Buying Call or Put options, we have either the right to buy or sell the underlying asset on expiry. Buying options is considered a ‘debit’ because we are paying the premium upfront for the contract.

The option buyer has the opportunity to earn unlimited profit by just paying a premium and the loss is limited to premium invested.

When selling Call or Put options, we have either the obligation to buy or sell the underlying security at a specified price (the strike price). Selling options is considered a ‘credit’ as we receive the premium for the contract we sold.

In Selling an option the profit is limited to the option premium received but the potential for loss can be unlimited.

When To Buy and When To Sell Options?

Option buyers prefer to buy an option at a cheaper price and sell it at a higher price. One has to buy options when implied volatility is relatively low. For option buyers, delta is the friend and time value is the enemy. So, we should buy slightly in-the-money options. ITM options have less time value compared to ATM and OTM options which have 100 percent time value and delta is relatively high in ITM options when compared to ATM and OTM options. So, slightly buy  ITM options when implied volatility is relatively low.

Option sellers prefer to sell when an option price is higher and buy it back later when the price is cheaper. We have to sell options when implied volatility is relatively high. For option sellers, time value is the friend and delta is the enemy. So, we should sell slightly or deep out of-the-money (OTM) options. OTM and ATM options have a higher time value compared to ITM options. So, Sell OTM options when implied volatility is relatively high.

Conclusion:

Buying option is to be done when implied volatility is relatively low and when we expect the underlying asset to make a big move.  

Selling option is to be done when implied volatility is relatively high and when we expect the underlying asset to remain sideways or directionless. 

Risk can be handled with a better understanding of the option Greeks. 

 

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