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Option Buying vs Option Selling

Buying versus selling options

An option is a derivative instrument or a contract that gives the holder of the option a right but not an obligation to buy or sell an underlying asset like a stock or an index at a later date at a fixed price.


Options as we know are of two types- call option and put option. In the case of a call option holder of the option gets a right and not an obligation to buy and in the case of a put option, the holder gets a right but not an obligation to sell the underlying. Call options can be bought and sold likewise put options also can be bought and sold.


Buying and selling of options depend on the risk and return appetite. An option buyer is a person who pays the premium to buy a hedge against a perceived risk or simply trade while the option seller known as the writer agrees to underwrite the risk. Buying and selling serve two different purpose-where the buyer is an insured who pays the premium and the seller is the insurance company that collects the premium. The risk and return profiles for both are poles apart.

Buying of options

The benefits of buying an option are multi-fold. Apart from hedging, option buying offers the advantage of leverage and better return on investment. For example, the current market price of the State Bank of India (SBI) is Rs.430 and Mr A based on his analysis and perception thinks SBI can move up substantially in the short term.


There are two ways he can do it- either buy SBI in the cash market by paying the money or buy a call option. Suppose he wishes to buy 500 shares of SBI then he will have to deploy Rs.2,15,000 in the cash market.  Instead, Mr A can buy an SBI call with a strike price of Rs.430 at an Rs.14 premium. The lot size of SBI is 1500. His net outgoes will be Rs.21,000 (1500 X 14).


One can see how leverage helps by deploying only around a small fraction of an amount Mr A can buy three times the quantity. The maximum risk here is Rs.21,000. If before expiration the SBI call option moves to Rs.24 Mr A can sell the option and square off his position and make a quick profit of Rs.15,000 (1500 X (24-10)). The return on investment is also far superior to the cash market trade. In the above example, the ROI is 71.4 % (15000/21000). 


Similarly, if Mr A feels SBI shares may fall shortly he can buy a put instead of selling his holding in SBI. For example, Mr A buys an SBI put of the strike price of 430 at Rs.7 premium expecting the stock to correct. If before expiry SBI comes down and the put moves up to Rs.17 then Mr A would make a profit of Rs.15,000. 

Drawbacks of option buying

Option buying does have its share of drawbacks. Liquidity is one of the major problems in stock options. This results in the bid-ask spread and impacts the entry and exit of options. Another important thing an option buyer should beware of is time decay. An option is subject to time decay and the value of the option decreases each day. If an option that is bought does not move faster than expected one must try and exit as the option is subject to decay. Non-availability of stock options for all the stocks makes hedging difficult.

Selling of options

Selling options unlike buying options comes with an obligation. At expiration, an option seller is legally bound to deliver the shares to the option buyer. Therefore, option sellers require huge margin money.

Covered and naked selling

Option selling for both put and call can be of two types-covered and naked. Covered options writing is done when the underlying stocks are held at the time of writing. Naked option writing means there are no underlying at the time of writing of options.


For example, Mr A who owns 1500 shares of SBI sells a call of SBI and is establishing a covered call position. If on the other hand he already sells his SBI shares and sells a put against it he has established a covered put position.


In naked option writings, there are no underlying shares held by the option writers. For example, by selling an SBI call without having any shares of SBI in hand Mr A establishes a naked call position. Similarly, if Mr A sells a put without selling any corresponding shares, a naked put position is established.

Option writing involves limited return and maximum risk

An option seller makes money to the extent premium is collected. If the option sold becomes “in the money” then the option writer will start making losses. If the option remains “out of the money” the option seller will make money. This is because of time decay. An option has an expiry it decays every day and on expiration becomes negligible. We will learn more about time decay when we cover option Greeks. Since the option writer is under obligation to provide the shares on expiration his risk becomes very high in case the position goes against him.


Selling of options is a highly professional occupation that requires high levels of risk & money management. Selling options is not for the feeble-hearted. Selling options is a risky business. In buying the maximum loss is the premium that is paid while in selling the risk is unlimited. Apart from this option sellers require margin money to sell the options making a return on money less attractive. 


Insurance is bought to guard against the happening of a future event. An option seller is like an insurance company that undertakes to write risks of an option buyer for a premium. The probability of the event happening is very less and therefore, statistically, option writers make more money than the option buyers.

Frequently Asked Questions

What are the benefits of option buying?

Option buying helps in hedging, and leveraging and offers a better return on investment


What are the drawbacks of option buying?

Time decay, liquidity and non-availability of options for all the stocks are the three most important drawbacks of option buying.


What are the types of options selling?

There are two types of option selling-covered selling and naked selling. 


What is covered selling?

Covered selling involves having an existing position in the stocks before selling options.


What is naked selling?

Naked selling or writing involves the selling of options without having any existing position.

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