i have a question suppose if i am bullish why i will sell put instead of buying a call i know abut the risks of selling but other than that i want to know why people write or sell options?
Let me illustrate this with an example. Suppose you are bearish on Tata Motors. In this scenario, you can either buy PUT option or sell CALL option.
Now if you buy PUT option you will be profitable only when the underlying goes down. And you will loose when the underlying goes up or move sideways. So mathematically there is 33.3% chance of profit here.
Instead, if you’ll sell CALL option, you’ll be profitable when the underlying goes down or move sideways. Whereas you’ll loose only when the underlying goes up. So there is 66.7% chance of profit here.
This is the only reason why low risk averse people prefer to sell options than to buy them.
When you are bullish on a stock , you have two options:
1. To Short a PUT 2. To buy a CALL
Now, as a general statistic, it is a very much known fact that out of all traded options only 20% options expire ITM and 80% expire OTM. So, sellers are most of the time the winners. So, if you are selling a put instead of buying a call you are already increasing your PROBABILITY of success.
Apart from this, lets look how options exactly works and why this probability works in favor of option shorters. An option premium is made up of two components:
Option Premium = Intrinsic Value+ Time Value
Now, When you buy an option, lets say, you buy a call, hoping the option premium to increase, now the intrinsic value will increase as long as the stock increases, but the time value , which is another component of the option premium will ALWAYS decrease with each passing day as time to expiry is limited and options are limited time period instrument. So, for a buy call to increase the stock has to move exponentially, session after session, then only the INTRINSIC VALUE will overpower the decreasing TIME VALUE also know as Theta Decay.
Sometime the stock prices increase then go sideways and just consolidate for few sessions, in this case time value will keep decreasing as each day passes by and intrinsic value will also not increase as stock is going no where. Even if the stock rises after a period of consolidation, it shall rise meteorically, in order to overpower the time value.
This is how it works in favor of shorters and that is why option shorters have high probability of winning as TIME DECAY will always work in their favor.
There is good advantage of writing options. I am an Intraday trader I will explain in that way.
For example Nifty spot is at 8650. It fell down to 8625. I am bearish now.
Case 1 : Consider I bought 8600 PUT. If Nifty moves to 8580 I will get good return with this 8600 PUT. If Nifty sideways. My 8600 PUT got eroded. I will be in loss even Nifty not rise.
Case 2 : Consider I short 8650 CALL. If Nifty moves to 8580 I will get good return with this 8650 CALL. If Nifty sideways. My 8650 CALL premium got eroded I will be in Profit.