Difference Between Option Buyer and Option Writer?

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.

What is the Difference Between Option Buyer and Option Writer?

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.

1. The buyer of the call option has the right to buy the underlying asset but does not have the obligation to buy. That means; the buyer of the call option will only exercise the option if the price is favorable, otherwise, the option will be left to expire.
2. The buyer of the put option has the right to sell the underlying asset but does not have the obligation to well. That means; the buyer of the put option will only exercise the option if the price is favorable i.e., it is lower, otherwise, the option will be left to expire.
3. The buyer of the call or put option gets the right to buy or sell without the obligation corresponding to it. Hence, the seller or writer who offers this privilege to the buyer of the option must be compensated. That compensation is the option premium or option price and is the maximum cost of the buyer of the option.
4. The seller of the call or put option takes the obligation and gives the right to buy or sell without the obligation corresponding to it. Hence, the seller or writer who offers this privilege to the buyer of the option earns the option premium or option price. This is the maximum profit that the seller or writer of the option gets on the contract.
5. The buyer of the call or put option normally has an affirmative view of a stock. For example, the buyer of the call option expects the price of the stock to go up and the buyer of the put option expects the price of the stock to go down. Their views may differ but they are affirmative nevertheless.
6. The seller of the call or put option normally has a non-affirmative view of a stock. For example, the seller of the call option does not expect the price of the stock to go above a certain price level and the seller of the put option does not expect the price of the stock to go below a certain price. Their views may differ but they are non-affirmative nevertheless.
7. The buyer of the call or put option is normally a hedger but it is quite often a speculator too since the losses are limited. This makes it much easier to speculate in options using the buy options mode.
8. The seller or writer of the call or put option is normally a hedger and rarely a speculator since the risk of naked option selling is too high. This makes it much tougher to speculate in options using the sell options mode.
9. Buying options is normally done by the retail investors and proprietary desks looking to cash in on trading and speculative opportunities in the market.
10. Selling options is normally done by the institutions and large non-directional traders looking to make limited risk-return trade-offs.

Option writing can be a double-edged game

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.

Advantages of option writing?

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.

How is options trading done?

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.