An insurance company collects a premium. If a person has cancer, smokes, drinks and works in a high risk job such as construction the insurance company will charge the person a high premium to compensate for the added risk of illness accident or death. The premiums collected from all high risk customers will more than compensate for any of these individuals dying.
The same is true for financial markets.
Options belong to the larger group of securities known as derivatives. Derivative word is associated with risk-taking.
Insurance seekers buy Put options. Insurance companies mostly sell Put options.
WHY SELL CALL OR PUT OR BOTH OPTIONS:
Sellers need to note the risk is not defined in advance. The trades needs continual monitoring and adjustments. You can't afford not to monitor the positions.
It involves managing margins, making continual adjustments and does involve some amount of stress as risk is not defined in advance. Again, the returns are lucrative. From 50% to 100% a year, depending on the trader's skill level.
Most of the time, options buyers are willing to pay more than the fair value of the underlying instrument depending on the sentiment in the market. Implied volatility (or market sentiment) generally overstates realized volatility. This largely results in the profit opportunities for the seller. When volatility goes up, it becomes imperative to manage margins and monitor positions.
Time plays an important factor. Seller can let time-decay work in their favour .
As the option gets closer to the spot price of the underlying (deep-in-the-money), the time value disappears.
By selling options, the trader earns healthy returns. If you think the currency pair price is going to stay relatively flat in the near future, you can earn a positive return by selling a call or put option. If the underlying price and implied volatility stay the same, that trade can turn profitable.
In short, these are the few reasons why someone might consider selling options:
- Generation of Income
- Exploiting changes in volatility
- Making the most out of market neutrality
Income generation: When you sell an option you collect the premium. That is real money in your account. Time decay is a certainty and that makes for a virtual daily income stream paid to the option seller.
Selling volatility: An option is more valuable when volatility in the underlying is high. Therefore traders prefer to sell options when volatility is high. By doing this they hope to profit from the collapse back to mean level levels.
Market neutrality: Option selling provides a degree of market neutrality. As long as the strike price isn’t reached, a short option position generates the same cash flow, regardless of what the market does in between.