Who makes more money?
Options Buyer or Options Seller?
Option trading is a fascinating activity, and you can earn good profits if you do it carefully. You can either buy options or sell them depending on what your view of the underlying is. However, one question that puzzles many is who makes more money: the option buyer or option seller?
Let me answer this question today.
As you know the stock market is always a zero-sum game. It means that either the buyer or the seller can make a profit, but not both. The amount of profit gets transferred from the party making a loss to the one that is making a profit.
Payoff profile for Option traders
- An option buyer can make limited losses (i.e., the premium paid) but his losses are unlimited.
- On the other hand, an option seller can make limited profits up to the premium paid, but he/she stands the risk of getting unlimited losses.
Who earns more in the long run?
In the long run, the probability that both the buyer and seller will make money must be equal. This is because if only the buyers make money then nobody will sell options and if the sellers make money then nobody will buy options.
From our experience, we have seen that:
- The seller of options makes profit more frequently, but he/she earns small amounts every time and
- The buyer of options earns larger profits from each winning trade, but he wins less frequently.
In other words, it is possible that
- The option seller may earn Rs. 100 for 5 times and
- The option buyer is likely to make a profit of rupees 500 from 1 trade.
In the long run, the seller makes profits from more trades than the option buyer, but their amount of profit earned by them are similar.
Should you be an option buyer or an option seller?
There is no straightforward answer to this question since it all depends on the risk appetite of the option trader.
If you are interested in making big profits from one trade, then you should go for buying options. If you are satisfied with making small profits multiple times, then you can sell options.
You must remember that you will be assuming a payoff profile of limited profits and unlimited losses if you sell options. Hence you will have to always maintain a strict stop loss to avoid facing huge losses.
Many option buyers aim for big profits and end up losing the premium when their view goes wrong. So, over a six-month period, it may happen that in the first five months they lose the premium, get demotivated and exit the market. However, in the sixth month, if the market moves up, they do not earn big profits since they are out of the market.
On the other hand, the option sellers get a chance to make profits more frequently. This is because as time passes by there is a decay in the time value of the options. So, the option seller can hold the position and make small profits frequently.
The option seller always however must maintain a strict stop loss to ensure that he does not earn a huge loss when the market makes a one side movement. If that happens the stop loss will be hit, and he will exit the position with a small loss.
So, as I have said earlier there is no straightforward answer to whether you should be an option buyer or option seller. It all depends on your risk profile and the number of trades that you want to execute.
If you have any further questions, feel free to get in touch with us.
This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.
