Guess you can make money selling options?

"The big fishes in the market make loads of money selling options. It's like being an insurance company which takes premium from a lot of people and pays back only to a handful". 

At the face of it, such statements sound logical for following reasons -

1. The option seller can carefully sell options which are opposite to his market perception i.e. he can sell puts if he is bullish and calls when he is bearish. 
2. He can choose the distance of his sale from the spot price, further reducing his risk. 
3. He can choose from various option strategies depending on market conditions and also hedge his position etc.

There are many options strategies to choose from, but to understand their risk/reward, let's use below example of a "Bull Put Spread" for an Indian equity index, Nifty 50. You can do the risk/reward math for other options strategies but I would insist that they would be similar, if not exactly same.  

Example:

Today's Date - 27 March 2017
Options Strategy - Bull Put Spread (Options Expiry 27 Apr 2017)

Nifty Spot Price = 9045

Sell Nifty Put = 8800

Buy Nifty Put = 8600

Maximum Risk = 8800-8600 = 200

Maximum Gain = Premium received. 

Goal - Sell options far away from spot price in the direction opposite to market trend with the view that options will most likely expire worthless and seller can keep the premium. 

Now let's look at premium situation - 
(Nifty Option Chain - Expiring 27 April 17 (Today's date - 27 Mar 17))

• Premium for above-mentioned Option Strategy would be: Rs 35.00 - Rs 14.05 = Roughly Rs 20
• Maximum Risk = Rs 200 (8800-8600)
• Risk/Reward Ratio = 200/20 = Risk 10 times higher than reward.
• Minimum Adverse Price movement for Option to enter in the money (ITM) = SPOT Price - Put Sell Price = 9045 - 8800 = 245 (In percentage terms, Nifty has to move 2.7% from Spot Price before the losses start hitting.
• If you move farther from SPOT price, the risk/reward becomes higher and chances of nifty moving that percentage become lower which even things out. e.g. for a put spread of (8700-8500), Nifty will need to adversely move by 3.8% before losses start but the premium would 1/16th of the maximum possible loss.   

Now you may think that I did not consider probability of nifty moving 2.7% while calculating risk/reward ratio. Let's see below

(excerpts from https://en.wikipedia.org/wiki/NIFTY_50)

Nifty Major Falls

1. 11 Nov 2016 --- 229.45 Points (driven by US election results & demonetisation move by the government)
2. 24 June 2016 --- 181.85 Points (driven by the Brexit referendum)^[7]
3. 24 Aug 2015 --- 490.95 Points (driven by meltdown in the Chinese stockmarket)^[8]
4. 06 May 2015 - NSE Nifty slipped below the 8,200-level by falling 179.25 points or 2.15 per cent to 8145.55. Besides, overnight losses in the US markets on worries about surging oil prices, poor trade data and growing tensions over the Greek debt crisis weighed on sentiments.^[11]
5. 16 Aug 2013 --- 234.45 Points(because of rupee depreciation)^[9]
6. 27 Aug 2013 --- 189.05 Points^[10]
7. 03 Sep Aug 2013 --- 209.30 Points
8. In 1991, New Delhi kickstarted the economic reforms process owing mainly to the serious balance of payments crisis it was facing.
9. 1997 Asian Financial Crisis - Investors deserted emerging Asian shares, including an overheated Hong Kong stock market. Crashes occur in Thailand, Indonesia, South Korea, Philippines, and elsewhere, reaching a climax in the October 27, 1997 mini-crash.
10. 21st January 2008 Nifty went down by more than 10% on a single day due to US sub-prime crisis. That was the beginning of a year-long bear market

So, at least in recent times, every year provides us with one or two opportunities when nifty moved at least 3-4% in a day. And remember, this is just the Nifty Major Falls list. Similarly, there would be Nifty Major Highs which may bite you in case you are short on the market. 

Conclusion

In conclusion, as we see, one adverse Nifty movement can eat up your profits of last 10 successful monthly transactions and chances of that event happening are far from remote. Is options selling still a good investment opportunity? Probably 'Yes' for a privileged market operator who keeps changing his market position regularly by constantly monitoring the market, volatility, time et al and using some algos etc. but I don't see how it can make a retail investor rich. Thoughts?