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Expert Traders, Who Earn Lakhs Of Profit Every Month, Debate Whether Options Buying Is More Profitable Or Options Selling



Options trading has caught the fancy of traders in Dalal Street. Not a day goes by without the traders posting screenshots of massive earnings. However, the controversial debate as to whether “options buying” is more profitable as compared to “options selling” has still not been resolved




Warren Buffett calls Options “Weapons of Mass Destruction” but still indulges in them

Warren Buffett spooked an entire generation of investors and traders by describing “derivatives” (i.e. futures and options) as “weapons of mass destruction” in his letter of 2002.

“I view derivatives as time bombs, both for the parties that deal in them and the economic system,” the Billionaire said in a stern tone.

“In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal,” he added.

Later, in his letter of 2008, Warren linked the collapse of Lehman Brothers and the ensuing financial catastrophe to the misuse of derivatives.

“Derivatives are dangerous. They have dramatically increased the leverage and risks in our financial system. They have made it almost impossible for investors to understand and analyze our largest commercial banks and investment banks ….

… The Bear Stearns collapse highlights the counterparty problem embedded in derivatives transactions, a time bomb I first discussed in Berkshire’s 2002 report,” he said.

However, the fact is that Warren Buffett has himself been using options to rake in big bucks for himself and his shareholders.

He disclosed in his 2008 letter that Berkshire Hathway has “put contracts” totalling $37.1 billion which are spread among four major indices such as the S&P 500.

The said contracts have earned premiums of $4.9 billion (which has been invested).

The total amount at risk is $37.1 billion.

Warren suggested that the risk of a loss is remote.

“One point about our contracts that is sometimes not understood: For us to lose the full $37.1 billion we have at risk, all stocks in all four indices would have to go to zero on their various termination dates. If, however – as an example – all indices fell 25% from their value at the inception of each contract, and foreign-exchange rates remained as they are today, we would owe about $9 billion, payable between 2019 and 2028.”

Warren also stated (in 2008) that there was an “estimated loss” of $10 billion which required reporting of a mark-to-market (MTM) loss of $5.1 billion from the put contracts.

Presumably, the estimated loss figures may be enhanced now given the steep collapse in the Indices due to the Covid-19 pandemic.

Warren provided an explanation about the fate of these contracts in the 2020 meeting.




Option buyers always lose money: Option sellers

A young trader named Mitesh Patel has become the cynosure of all eyes in Dalal Street because he has been repeatedly boasting of massive earnings from options.

In addition to posting weekly screenshots, he has claimed to have earned a mammoth amount of Rs. 3 crore in just 19 months from options. The return in FY 2019-20 is said to be a mind-boggling 428%. The return over 26 months is said to be an unbelievable 1694%.

“A new definition of multibaggar return in trading … Catch me if u can,” he said, evoking admiration and envy from his followers.

He has claimed that “option buying” is a tool to “lose money slowly” and that “option selling” is the road to riches.

However, this sweeping statement has not gone down well with other traders who have made a fortune out of “options buying“.

Asit Baran Pati, a trader who reported an earning of Rs. 77 lakh a few days ago, argued that while option buying has limited risk, option sellers are “dipping into the river of risk” and may not be able to come out “without drowning“.

He also claimed that an option buyer who knows “how to catch the trend with momentum” can make a fortune from option buying.

He also argued that option buying returns are unmatchable to option selling, given that it is without any leverage, and risk management is easier.



Both strategies have their place in a trader’s armoury

Other experienced options traders pointed out that it is fallacious to label either strategy as good or bad.

One has to adopt the appropriate strategy depending on the market conditions and other circumstances.

However, some veteran traders like Peter Brandt are unhappy with both strategies. Presumably, he prefers “futures“.

The merits and demerits of the two strategies have been explained in an objective manner by Projectoption, with a number of real-life examples.




OTM Options are a “Hero Ya zero” Game

Most traders have a fascination for buying “Out of the Money” options because they are dirt cheap.

These options can generate a massive fortune if there is a sudden and sharp movement in the Indices or stock.

In fact, a trader was able to convert a paltry sum of $766 into a fortune of $107,758 due to buying OTM Put Options in a volatile stock named ‘Roku‘.

There are a number of other examples where options costing only a few paise have surged multifold.

However, other experienced traders claimed that “OTM options” are a way to lose money and that only “ITM Options” can generate huge returns.

Options Seller loses $150 Million and goes bankrupt

Warren Buffett’s warning that derivatives are “weapons of mass destruction” is obviously not without substance.

A well-known trader named James Cordier lost $150 Million of his clients’ funds because the crude oil prices plunged below the put strike prices and created unmanageable risk.

It appears he indulged in “Short Strangles” which is said to be “the most dangerous strategy in a trending market“.

A number of other options sellers have reportedly gone belly-up such as Karen “the SuperTrader” and Victor Niederhoffer.



Use risk-defined options strategies only

It appears that if we are inclined to dabble with options, we should always confine ourselves to “risk-defined” strategies which have a limited loss potential.

Some of these strategies are Iron Condor, Iron Fly, Butterfly, Vertical Spreads, Call Calendars etc.

This way, even if things go haywire and there is a Black Swan event, the risk is within limit of tolerance.

It also appears that SEBI has loosened the margin requirements for these strategies, which makes them worthwhile from a ROI perspective.

So, it is better if we also gear up to learn the new tricks of the trade and start making money like the others on Dalal Street!

See Also: Mom And Pop Traders Throng Dalal Street, Enticed By Screenshots Of Massive Earnings Of Other Traders









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1 Comment
  1. Rajeev's Gravatar Rajeev
    January 18, 2022 at 4:35 pm | Permalink

    Those who understand options can play well, then it is one of the best ways to generate regular income.

    Reply

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