Option Buyer v/s Option Writer

An Option Buyer is someone who buys an option from sellers/ writer. The buyer of an option pays a premium and buys the right of that particular option but is not obliged to writer to exercise the option.

Buyer of an option has limited risk up to the premium paid, and theoretically it can earn unlimited reward if stock/index moves significantly higher (in case of call) and lower (in case of put). The biggest risk is of time decay and drop in volatility. If market remains range bound or near expiry, premium will erode faster due to time decay factor, which will result into negligible profit or may turn into losses.

Options should be bought only when you are confident that stock/index will move significantly either side because if stock/index remains range bound, the premium of both At-The-Money and Out-The-Money options will decrease and become zero till expiry. Advance traders can also buy options if they expect volatility to shoot up.

An Option Writer is someone who sells an option but without holding any long positions, it is like short selling the stock/index. The option writer receives premium and has the obligation to keep the agreement if buyer of an option exercises his rights. Writer of an option has a higher probability of making money compared to an option buyer. Option writers primarily trade on time decay and volatility, while market movement is secondary factor. Following are the two scenarios where option writers can initiate positions:

If he expects stock/index to trade sideways and volatility is expected to go down.

If he expects stock/index to move higher (if a put option) or lower (if a call option).

Following is the payoff table of Option buyer (Long Put Strategy)

Following is the payoff table of Option Writer (Short put strategy)

Piece of Advice:

Investors, who have a low risk appetite, should stick to basic strategy like option buying, whereas option writing should only be used by sophisticated investors as risk involved in writing of an option is higher compare to reward.