Option writing is a system. A system is an activity which can provide a profit or a return because it has an edge. In case of option writing, the edge is 2 out of 3 times the options expire worthless. Reading the odds is important, this can mean 2 out of 3 months or 2 out of 3 times you take a position. 2/3 converts to 68% probability. which is probability that prices will stay within 1SD of the present average price. (Unable to understand, Visit Varsity) Edge of this system is 18%. Read on, you will see how.
Compare this to a Monkey Trading. If A monkey (a computer) is blindly buying and selling a at regular intervals of 1 day, then probability of making money is less than 30% or 1/3. This kind of monkey trading can increase the odds up to 50% if technical or quantitative pattern seeking is used in buy sell decisions. The odds are not still more thanks to Options and the Volatility. Read on, Market is ZERO SUM you will see.
Option writers take the money away reliably, from equity traders and option buyers alike. Reliably, like how amazon, apple, reliance and our girlfriends (hope you are not single ) take money away from your wallet reliably. They have an edge… Competitive advantage. This advantage is psychological in Trading, you will see how in next para.
The edge is calculated by subtracting the baseline (monkey trading) 50% from the 68% of the option writing probability giving 18%. Now multiply the edge with the money that your are investing, that is the competitive advantage of Options Writing.
Looks as if I am saying everyone should write options. Hold yourself, and think about the odds. Can you predict the perception of volatility of the market? Without being able to see the Volatility. That is 3 levels of beliefs that you have to predict. Real volatility, Markets Perception and the Writer’s Perception. We retail traders are in market trading beliefs, not prices or value. Answer for why the competitive advantage in Trading is Psychological.
It is fascinating to trade as fundamental, technical and quantitative trader and finally distill it by writing here. We can move to higher plane if we strive for it. Firstly we need to practice thinking in probabilities.
Option writing works especially well because the option writers understand volatility and the probability better than option buyers and equity traders. If the option buyers realize the volatility is their friend too, and that volatility can negate the impact of theta, the belief on option as a system will increase. Oh, our friends equity traders might end up suffering though.
To answer you, you can find out that @Joe_Chris is making money 2:1. If joe writes options worth 30,000 INR for 3 months, he will make 30,000 INR for 2 months and lose 30,000 INR in 1 month or more. He can average it out to an year, that is (460,000-430,000) 120,000 INR which is 10,000 INR per month. This 10,000 INR is achieved only 68% of times. (Think probabilistically, because the writer or betting that the siren called Black Swan is very, very rare, and it is) Not a bad returns for 30,000 risk. @Joe_Chris, your insights would be valuable here.
Option writers or buyers need not take the money from each other, when our friends the equity traders who use their technical, quantitative, fundamental analysis to move the prices and give their money to option traders. We are straddling, Strangling , or spreading their risks as profits on our plates. We all have to remember trading is a ZERO SUM game.