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We know that an option in financial parlance is the right to buy or sell an asset without the obligation. For this right without the obligation, the buyer of the option pays a price which is called the options price or the option premium. That means; there are 2 parties to the options contract viz. the option buyer and the option writer (seller).
You can look at understanding this entire debate about option buyer vs option writer. The option writer takes on the unlimited risk for limited returns while the option buyer takes on limited for potentially unlimited returns. If you think that this option writer vs option buyer debate is skewed in favor of the option buyer think again. Globally, nearly 85% of the options expire worthless so there is an 85% probability that the seller or writer of the option makes money and the buyer loses money. That lies at the core of the option writer and option buyer difference.
To understand this option buyer vs option writer debate, it is essential to get into the core difference between the view and the pay-offs of an option buyer vs option writer in an options contract. Here are some key areas of differences between option writer and option buyer.
The buyer has the right but is not obliged to buy/sell an asset underlying at a set price on or before a particular date. An understanding of what an option is and what terms like call and put options help anyone interested in knowing about an option writer.
Writing options may be statistically more rewarding but it is a complex game. While it has its merits, it has its risks too. Let us look at the merits first. Writing (selling) options results in upfront premium earning, availability of full premium if the option expires OTM, benefits of time decay, and the advantage of trading out of liquid options. The risks of writing options include adverse price movements, the impact of spikes in volatility, shifts in macros, higher-margin calls, etc.
Options writing has some unique advantages in the sense that it results in upfront premium earning, availability of full premium if the option expires out of the money or OTM, benefits of time decay as expiry approaches, and the advantage of trading out of liquid options. More importantly, when you sell options, you are on the same side as the better-informed investors.
Options trading happens through the normal trading mechanism and the clearing and settlement are also done through the clearing corporation of the exchange. Options trading is just like cash market trading with some added complications of strike prices expiries etc.
That is a hard one and would entirely depend. The golden rule is to sell overpriced options and to buy under-priced options. The best options traders do not get stuck to any one side of the options trade but are agnostic based on opportunities and valuations of options.
Time value of an option is the residual value after the intrinsic value is removed from the price. For example, if the price of the stock is Rs.845 and the Rs.840 ITM call is trading at a premium of Rs.10, then out of the premium, Rs.5 is the intrinsic value which is the gap between the stock price and the strike price. The balance Rs.5 is the time value of the option. Normally, only ITM options have intrinsic value and time value. ATM options and OTM options only have time value.
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