One of the most widely debated issues in options trading has been what pays off more — net buying of options or net selling. I had an opportunity to sit with a great set of Options traders and we were finally able to find an answer to it.
The answer is it ‘depends’.
Also, when we say net seller, one is required to be skilled enough to understand the unlimited risk profile of it and know how to handle it just in case if the view were to go wrong.
Factor #1 Time
Much talked about wasting attribute of option premium is least required to explain. While the option premium keeps losing an element of its premium due to the passage of time, the time value hit on the option premium is not constant.
The nature of decay of time value element from option premium is rather slow in the beginning of the expiry and picks up speed as it comes closer to the expiry and is at a great speed in the last 5-7 sessions of the expiry.
Hence, if we are in the early part of the expiry be a net Buyer, while towards the end of the expiry be more on the net selling side.
Factor #2 Implied Volatility
This fancy element in plain English is the expensiveness of the option. It results in inflation in premium just because the expected volatility is high ahead of an event and deflation because an event has passed by and calmer times are expected ahead.
Funny as it is without an event, the implied volatility also has its own characteristic. More often than not it moves in the range. Here, instead of sharing what to do, let me share what not to do.
So if the implied volatility, generally observed from its indicative index of Nifty options called India VIX is observed close to recent high refrain from having a Buy and hold strategy with single or combination of options.
On the other hand, if we have the same index is close to recent lows, refrain from being a net seller in the options.
There are certain theories that do guide selling options when Implied Volatility is at higher extreme and buying when it is otherwise. However, finding these extremes is a separate topic of discussion itself.
Factor #3 Underlying Trend
It is not difficult to find what the trend is, as being no expert on price analysis also one would be able to see whether the last bottom has been higher than the previous one along with the last top being higher than the previous one.
If so, the underlying is an uptrend and if it is otherwise then the trend is down. Simply refrain from selling net calls in an uptrend and most importantly (the source of maximum trading casualties) refrain from selling Puts in a downtrend.
There could also be the situation which would not fit these situations like a smack down in the middle of the expiry and around average implied volatility or in consolidating times. In such situations be a subscriber to Vertical spreads with an equal quantity of buy and sell.
Otherwise, just be observant of characteristic induced Option Buying or Selling opportunity as they give an extra edge just by being in the right trade setup.