OPTION BUYING

vs
OPTION SELLING
 What Is Option Buying And Selling?
Option buying
● When you buy an option, you are essentially paying for the right, but not the obligation,
to buy or sell the underlying asset at a specified price on or before a specified date.
● The maximum loss that you can incur when buying an option is the premium that you
paid for the option.
● Your profit potential is unlimited if the underlying asset price moves in your favor.

Option selling
● When you sell an option, you are essentially collecting a premium in exchange for the
obligation to buy or sell the underlying asset at a specified price on or before a specified
date.
● The maximum profit that you can make when selling an option is the premium that you
collected.
● Your loss potential is unlimited if the underlying asset price moves against you.
It has been seen that a seller of an option has 2/3rd chance of making profit
whereas a buyer of an option has only 1/3rd chance of making profit.
The Key Differences Between Option Buying And Selling
 Why Does Option Selling Require
More Margin?
Option selling requires more margin because the losses can be unlimited. When
you sell an option, you are essentially collecting a premium in exchange for the
obligation to buy or sell the underlying asset at a specified price. If the price of
the underlying asset moves against you, you could be required to buy or sell
the underlying asset at a loss. The amount of loss could be unlimited,
depending on how much the price of the underlying asset moves.

To protect themselves from losses, brokers require option sellers to maintain a

certain amount of margin in their trading account. The amount of margin
required depends on a number of factors, including the underlying asset,
the strike price, the expiration date, the time to expiration, and the
implied volatility.
 Naked Selling vs Selling With Hedges
Naked selling is when you sell an option without owning the underlying asset. This means
that you are obligated to buy or sell the underlying asset at the strike price if the option is
exercised. Naked selling can be a risky strategy, as you could lose an unlimited amount of
money if the price of the underlying asset moves against you.

Selling with hedges is when you sell an option while also taking steps to protect yourself
from losses. This could involve buying the underlying asset, selling a different option, or
using a combination of these strategies. Selling with hedges can reduce the risk of naked
selling, but it can also reduce the potential profits.

The main difference between naked selling and selling with hedges is the level of risk
involved. Naked selling is a riskier strategy, as you could lose an unlimited amount of
money if the price of the underlying asset moves against you. Selling with hedges
reduces the risk, but it can also reduce the potential profits.

Naked selling requires higher margin compared to selling with hedges as it

involves huge risks and thus higher margin is blocked by the broker.
 When To Buy An Option?
You might want to buy options if you are:

● Bullish on the underlying asset and believe that the price will go up and
vise versa.
● Looking to hedge your risk against a decline in the price of the
underlying asset. (If you hold ITC shares and you believe that the
prices will go down based on some news or expecting a correction in
the market then you can buy put options and hedge your holdings.)
● Trying to profit from a short-term price movement in the underlying
asset.
 When To Sell An Option?
You might want to sell options if you are:

● If the price of the underlying asset moves in the direction that you are
expecting, you can sell the option for a profit. If you believe that the market
is bullish for sometime then you might want to sell put option and enjoy the
premium decay.
● The value of an option decreases over time, so you may want to sell OTM
options in order to generate income from premium.
● Selling options can be more attractive when implied volatility is high, as
high volatility tends to inflate options premiums.
Circumstances Under Which You Might Consider Buying
Or Selling An Option
● If you are bullish on the underlying asset: You might consider buying a call option. This gives
you the right to buy the underlying asset at a specified price on or before a specified date. If the
price of the underlying asset goes up, you can exercise the option and buy the asset at a lower
price.
● If you are bearish on the underlying asset: You might consider buying a put option. This gives
you the right to sell the underlying asset at a specified price on or before a specified date. If the
price of the underlying asset goes down, you can exercise the option and sell the asset at a higher
price.
● If you are neutral on the underlying asset and are looking to generate income: You might
consider selling covered calls. This involves selling call options on shares that you already own. If
the option expires worthless, you keep the premium that you collected. If the option is exercised,
you are obligated to sell the shares at the strike price, but you have already made a profit on the
shares.
● If you are neutral on the underlying asset and are looking to protect your
downside: You might consider buying put options. This gives you the right to sell the
underlying asset at a specified price on or before a specified date. If the price of the
underlying asset goes down, you can exercise the option and sell the asset at a
higher price, which will limit your losses.
 Risks Of Buying An Option
● Limited time horizon: Options have expiration dates. If the market doesn't move in the
anticipated direction within the given time frame, the option could expire worthless,
resulting in a total loss of the premium paid.

● Loss of Premium: When buying options, the maximum loss is limited to the premium
paid. However, if the option doesn't move in your favor, this premium could be entirely
lost.

● Volatility Risk: Options prices are influenced by volatility. If volatility decreases, it can
impact the option's value negatively, even if the underlying asset's price moves in the
predicted direction.

● Time Decay: As options get closer to their expiration date, they experience
time decay. This means the option's value erodes over time, especially as the
expiration date approaches.
 Risks Of Selling An Option
● Obligation to perform: Selling options, especially naked options (without proper coverage), can
result in obligations to buy or sell the underlying asset if the option buyer exercises their rights.
This can lead to unexpected positions that might be unfavorable.
● Unlimited Loss Potential: Selling options, especially naked call options, carry unlimited loss
potential if the underlying asset's price moves significantly against your position. Although the
premium received provides some cushion, large price movements can still result in substantial
losses.
● Margin Requirements: Some selling strategies, such as naked options, may require you to
maintain a certain level of margin in your account to cover potential obligations. Market
movements can impact your margin requirements.
● Market Adverse Movement: If the market moves sharply against your position, you might need to
act quickly to manage the risk or potentially face larger losses than initially anticipated.
● Implied Volatility Risk: Selling options when implied volatility is low can lead to receiving
lower premiums. If volatility increases after you've sold the option, it could negatively
impact your position.
● Limited Profits: Selling options generates premium income upfront, but the potential
for profit is capped at the premium received. Even if the market moves
significantly in your favor, your profit is limited to the premium.