Why actions by option sellers are important

1. Who are option sellers?
Rich investors, prop desks of brokers and FPIs mainly. Buyers are primarily Domestic institutions like insurance companies, mutual funds and banks and to a much lesser extent retail traders.

2. What’s the equation in terms of buy & sell?
Normally, FPIs are long Nifty and Bank Nifty futures, net short call options and net long puts. Clients and prop net sell puts and calls and are usually net long index futures. DIIs are net buyers of call and puts and net short stock futures. At all events for every buyer there must be a seller so the buy-sell equation balances out.

3. Why is options selling risky?
It’s risky because sellers are at risk of suffering huge losses compared with buyers, who pay premiums to buy calls or puts from the sellers. That is why a seller charges hefty premiums from buyers. Invariably sellers end up pocketing much of the premium buyers pay as they are better informed and have deeper pockets. However, hedgers loss in derivatives is offset by spot gains or vice versa. The losers tend to be retail level traders.

4. What’s the risk buyers face?
Each day of holding an option reduces its value due to time decay of the underlying stock or index remains flat. The longer you hold an option the more the time decay. Secondly, if you’re long an option and the underlier falls, you lose at square off. Also, if you’re long a put and the underlier rises you lose.