Option Seller has more advantage when compared to Option buyer in the longer run. Let’s see how.
Now consider, you did some analysis on the market movements and finalize that Market is bearish now and it is expected to go down in the coming days.
As an Option buyer, he would buy put option since his view is bearish and the Option seller would short the call option.
We know that there are only three possible scenarios in markets.
- Down trend
Markets tends to be in uptrend in few days and down trend in some days and most of the time it stays in range bound.
- Who bought the put option based on his bearish view in markets, if the markets starts moving upwards, then he would lose money.
- If market goes down as expected, then the option buyer who bought the put option makes money.
- But if the market neither goes up nor goes down, the option buyer losses money as the premium decays when there is no trend.
So option buyer can make money only one out of three scenarios. Only when the direction is right and the movement is swift, he makes money.
- Who shorted the call option based on his bearish view in markets, if the markets starts moving upwards, then he would lose money.
- If market goes down as expected, then the option seller who shorted the call option makes money.
- If the market neither goes up nor goes down, the option SELLER makes money as the premium decays when there is no trend.
So option Seller can make money two out of three scenarios. Statistically, over the longer run option seller tends to make higher returns.
Here’s the daily rate of change distribution of Bank Nifty, it denotes that most of the market tends to move between -1% to 1%, only less than 30% of the time, market range expansion happens and it tends to move beyond +1% or -1%.
I always emphasize this fact in our Option Trading webinar classes that if we could derive a strategy to trade the range bound markets and have robust risk management rules to protect the profit or limit the losses during trending times, then we have an absolute trading edge that could yield consistent returns over the years. This is where many option sellers miss out, they tend to make consistent returns, but when volatility spikes, they loss many months of profits over just few trades due to bad risk management.
I would always prefer Option short over long, as I have derived my strategy based on the above assumptions and that is what we convey during my webinars as well.