Buying option is more riskier than shorting it

There is common understanding among the option traders that shorting option is more riskier that buying it, in my view it is other way around. There is a statistics that 75% of the option expire worthless (of course these are the option contracts held till expiry; there could be cases where the option contracts are closed before expiry with profit).

There are four key factors which drives the option premium, let’s go over one by one in terms of both buyer & seller and see why selling is safer.

Price

Price is one of the key component to decide the option premium value. The price can go in three different directions. It can go up, go down or go in sideways. If you are a call option seller then two out of three price characteristics work in your favour. You no need to worry if the price goes down or goes in sideways. Also you need to worry if price goes up till the strike price of the short option. That means the third characteristics also work in your favour to some extend. Overall from Price movement perspective seller have upper hand than buyer.

Time

Time is another important factor which decides the option value. The option contracts lose it’s value as time goes by. That means it will always favour the seller. The buyers have no way to make the time to work in their favour.

Volatility

The most critical component which decides the option premium value, the volatility. It works both way for seller as well as buyer. If the volatility goes up then the option value will go up, that is going to favour the buyer and hurt the seller. There is a small catch that could benefit the seller here; most of the time, the option contracts trade in an average volatility, it goes up only wherever there a planned event that could possibility hit the price to move in either direction. It will be very few days in the calendar year. May be wherever the company is announcing the quarterly or annually results or any board meetings etc. Same thing with indics options wherever the country’s top bank makes any decision which could impact overall direction of the stock market. The point is, the days when the volatility will be higher is very minimal; the seller’s can very well avoid those days or have some kind of hedging to avoid unlimited risk.

Interest Rate

The last component which could decides the option contract values. Compare to other three components, it plays very negligible role, since the interest rate don’t change very often. So I could say that this factor can be skipped.

Overall the option sellers have upper hand in terms of winning probability. In theory they have unlimited risk. For example, if we short a put then literally the stock or indics can go all the way to go zero. Do you think the indics can go to zero? Indics like Nifty 50 or Sensex, it represents group of shares which have no way to go to zero on the same day. The indics option contracts are less risky than stock options and required less margin requirements.

The amount of money we are going to get from short selling is limited, but that is significant enough to make fortune. For example, if we short Nifty 9000 call and get at least 50 points as profit (no need to stay till expiry; close it when you achieve reasonable points). As of now, Nifty’s lot size is 75, so the profit is 75*50=3,750. Nifty roughly requires 50,000 as margin that means, it is 7.5% profit in a month. If you make at least 6 successful trade in a year, it is going to be 45% return in a year. (let’s assume that we miss or lose the remaining 6 months). In my opinion 45% in a year is really a BIG money.

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