Puts vs. Calls

Unsure whether to use puts or calls? These options give you the right to buy or sell a stock at a specific price by a certain time. Calls are for buying a stock you believe will rise in price, while puts are for selling a stock you think will fall. Learn more about puts vs. calls in our options trading guide!

What is a Put Option?

A purchase of a put option allows you the right to sell the underlying at a strike price. You can use puts to protect a long position from a price decline, but you can also use them even if you don’t own an underlying.

Here’s an example. Let's say Apple Inc. currently trades at $186.87. 1 put option in Apple with a strike of 185 and the July 6 expiration costs around $3 per share. It covers 100 shares.

You’ll have to pay $300 for 1 put. Then your long position in Apple will be protected until July 6. With the purchase, you limit your potential loss to $4.87 per share until July 6. Do the math by adding the premium of $3 to the difference between the market price and the strike of the put.

If Apple closes at $180 on July 6, you’ll exercise the option. This means that you are going to use the right to sell Apple at $185 and instead of losing $7, you’ll only lose $4.87. If Apple closes at $190 on July 6, your total profit would be $0.13, because you would make $3.13 by owning shares. You would lose the premium you paid for the insurance.

Above is an example of a put option that is almost $2 below the market price. If you want to buy the put whose strike equals the market price, you would have to pay a higher premium. The July 6, 187.50 strike put in Apple costs around $4. You have probably noticed that the strike is not the same as the market price.

This is because the example uses exchange-traded options. The exchange-traded options are standardized, so they don’t have a strike price for every market price. To get this, you would have to go off-exchange and buy an over-the-counter option. There are brokers that specialize in this type of trading and offer such contracts.

You don’t have to own the stock to trade puts. You could buy the July 6, 185 strike put, without owning shares of Apple. If in a week the stock trades to 185, your put would be worth more than $3 and you could sell it with profit. You can use this calculator to get the value of a put with 29 days till expiration and with the underlying market price of $185. The simulation shows that the price of the put would jump to $3.60, which means 20% profit on your trade.

You can trade puts like that even if you own the stock, but you won’t get a full compensation for the move of the underlying. In this example, the put gained only $0.60 and the stock lost $2.

Your option had a delta of -0.4 when you bought it, which means that it gains 0.4 if the stock declines $1. It also had a theta of -0.05, which means that it loses 0.05 as 1 day passes. When the stock declined to $185, our simulation showed that put’s delta dropped to -0.5. Investors can also use puts to generate income. If you sell a put, instead of paying a premium, you receive the premium and if the option expires worthless you make a profit.

So in the example, when you paid $3 for the July $185 put and the stock closed at $190 on July 6, the seller collected $3. When the price dropped to $180, the seller of the put had to buy the underlying for $185, but his or her net price was $182.

Why Should You Purchase Put Option?

Options trading can offer valuable opportunities in investing. One notable strategy is purchasing put options. This choice helps investors hedge against falling stock prices or profit from bearish markets. A put option allows the buyer to sell a specific number of shares at a set price before an expiration date. It provides protection in volatile markets and can lead to significant returns when used wisely. In the following sections, we will outline why investors should consider put options. We will discuss their benefits for risk management, profit potential, and overall portfolio strategy.

Hedge Against Market Declines

Investors with a stock portfolio often seek to protect themselves from market downturns. One way to do this is by purchasing a put option. A put option gives the investor the right, but not the obligation, to sell a stock at a predetermined price, known as the strike price. This must be done within a specified time frame. If the stock or market falls below the strike price, the put option increases in value. This helps offset losses in the underlying assets.

Speculation on Price Drops

Traders use put options to profit from price drops without having to short-sell the stock directly. Purchasing a put option can be more appealing than short-selling because short-selling requires borrowing the stock, selling it at its current price, and hoping to buy it back later at a lower price. On the other hand, with a put option, you pay a premium upfront and can benefit from the price decrease while minimizing several risks and costs related to short-selling, such as the potential for margin calls.

Limited Risk

Buying put options has the benefit of limiting risk to the premium paid for the option, in contrast to short-selling, where losses can be unlimited if the stock price rises unexpectedly. The option premium represents the maximum potential loss. Additionally, options offer leverage, enabling you to manage a larger number of shares with a smaller amount of capital, which can increase potential gains if the market moves positively.

What is a Call Option?

A purchase of a call option gets you the right to buy the underlying at the strike price. Instead of owning a stock, you can buy a call option and participate in a potential upside.

Your potential loss is limited to the paid premium and you get unlimited upside potential. If you want to buy the July 6, 190 strike call in Apple, you would have to pay around $2.80 and you would profit if the stock trades above $192.80 at the July 6 expiration.

If Apple closes at $200 on July 6, you exercise the call and buy the stock at $190. Your net price would be $192.80, but you could sell it immediately for $200 and make $7.20 per share. You could choose a different strategy and trade the call you bought before the expiration.

Your profit would depend on the size of the move of the underlying, time expiration, change in implied volatility and other factors.

Just like the put, you can sell calls and generate income. If the price moves against you, you would have to sell the stock to the buyer of a call. If you don’t already own it, you would have to borrow shares and take a short position.

Another popular strategy using calls is a covered call strategy. In this strategy, you own the stock and you sell a call against it. Your selling price is fixed or limited to the sum of the strike of the call and a premium collected, but on the other hand, the premium provides you protection.

Why Should You Purchase Call Option?

Investing in call options can be a smart choice for traders and investors. A call option allows the holder to buy an underlying asset, like stocks, at a set price within a specific time. This financial tool lets investors tap into potential high growth without having to buy the stock outright. It also requires less initial capital. Call options help investors profit from rising prices and can protect against losses in other investments. They add flexibility to an overall investment portfolio. In the next sections, we will discuss why buying call options is a good strategy for optimizing investments.

Leverage

Call options offer significant leverage. For a small investment, which is the premium for the option, you can control a larger number of shares of the underlying stock. For example, buying 100 shares of a stock at $50 would require $5,000. In contrast, a call option with a strike price of $50 might only cost a few hundred dollars. If the stock price rises, the percentage gain on the call option can exceed the percentage gain on the stock. This allows investors to increase potential returns without using a large amount of capital.

Limited Risk

When you buy a call option, your risk is limited to the premium you pay. This is a key advantage over other investment strategies, such as short selling or buying stocks. In those cases, potential losses can be significant. If the stock price does not rise as expected, your maximum loss is just the premium paid for the call option. This amount is usually much smaller than the losses from buying stocks outright or holding a short position. Because of this, call options are an attractive option for risk-averse investors who want to benefit from potential stock gains.

Profit from Price Increases

Call options are intended to profit from upward price movements of a stock. If you expect a stock to rise, buying a call option lets you take advantage of that expectation. When the stock price goes above the option's strike price, you have two choices. You can exercise the option and buy the stock at the lower strike price. Alternatively, you can sell the option itself for a profit. This gives you a chance to benefit from short-term price increases without having to own the stock. If the stock price increases significantly, the call option can offer a higher return compared to owning the stock directly.

Puts vs. Calls: Similarities

Used for Hedging

Puts and calls can be used for hedging. A trader with a long position, concerned about a possible market decline, is going to buy puts, while a trader with a short position, concerned about a sudden price increase, is going to buy calls.

Value Decays with Time

Puts and calls are sensitive to the time expiration. We use theta to measure how much an option is going to lose with an expiration of one day.

Sensitive to a Change in Implied Volatility

Implied volatility is expected volatility of the underlying and we use vega to calculate how much is an option going to change with a one percent increase in implied volatility. Higher implied volatility means a higher price for puts and calls and vice versa.

Used for Long and Short Positions

If you buy a call you have a long position that should make money in case of an increase in price, but if you sell a call you can lose money in case of a price increase. Traders who own puts have a bearish position and they can make money if the price declines. When we sell puts, we can lose money when price declines.

Puts vs. Calls: Key Differences

React Differently to a Change in the Underlying Price

We use delta to measure how much the price of an option changes in case of a $1 change in an underlying. Calls have a positive delta which means that they increase in value with an increase in stock price, while puts have a negative delta and they decrease in value with a positive change in an underlying.

React Differently to a Change in Interest Rates

We measure the effect of a change in interest rates on the price of options with rho. Calls increase in value with higher interest rates, while puts decrease in value.

React Differently as the Dividend Date Approaches

Calls lose value as we get closer to the dividend date, while puts increase in value.

Strike Differently Affects the Value of an Option

Calls with a lower strike have a higher value than calls with a higher strike, while puts with a lower strike have a lower value than puts with a higher strike.

Puts vs. Calls: Which Option is Better?

When looking at put options and call options, the key difference is in what the investor expects from the market. Call options are generally chosen when expecting the price of the underlying asset to rise because they provide the potential for unlimited profits. By purchasing a call option, investors can buy the asset at a set price, allowing them to gain from any future increase in its value.

Put options can be beneficial for investors who anticipate price drops. A put option allows the holder to sell an asset at a predetermined price, which is advantageous when prices decline; however, the potential profit is limited since the highest gain occurs if the stock price falls to zero.

The implications for writers of call and put options are different. Writing call options can lead to potential losses if the asset’s price rises sharply. This situation may require margin to cover possible obligations. On the other hand, writing put options can result in significant losses if the asset’s price drops. This also requires margin to manage the risk. In summary, call options offer unlimited gains but come with higher risk for writers. Put options provide limited profit but involve significant obligations in a down market.

Frequently Asked Questions