Making money in the stock market doesn’t have to be limited to buying good, dividend-paying stocks and holding them over the long term.
With options, you can do so much more than rely on dividend income or rising share prices to make money.
Whether you are looking to generate extra cash flow or protect your stocks from falling share prices, call and put options can help you to achieve your financial goals.
But when you compare call options vs put options, how do they differ and what do you need to know to make smarter trading decisions?
Calls vs Puts: Options Basics
Unlike stocks, calls and puts are traded in contracts. Usually one contract is equivalent to 100 shares.
If you buy 100 shares of ABC stock for $30 per share, it would cost you $3,000. But when you buy a call option or a put option it might cost you say $2 per share or $200 per contract.
The lower cost of buying options compared to buying stocks makes options very attractive.
Stock Trade vs Options Trade
To compare the profits of stock trades vs options trades, imagine the stock priced at $30 per share rallied to $100 per share.
In that scenario, you would make $70 per share or $7,000 in profits having invested $3,000.
But when you buy a call option for $2 per share or $200 per contract, you could make almost as much ($6,800) when the stock rallies to $100 per share yet risk a much smaller amount.
Whereas the stock buyer had to fork over $3,000 to buy 100 shares, the call buyer only had to shell out $200 to control the same 100 shares.
What’s the Catch Trading Options?
If you are new to options, this might be the time you think to yourself “wait, this sounds too good to be true”!
There is a catch and it is that options expire after a certain time period whereas stocks do not.
So, if the stock doesn’t move as you had hoped but instead stays at $30 per share, you lose nothing but time buying the stock whereas you could lose the entire $200 purchasing the call option.
The takeaway is that when you buy options, the underlying stock needs to move up or down to make money.
However, when you sell options, you can make money even if the stock doesn’t budge by even a dime.
Sound complicated? Let’s make it simple by highlighting the differences between calls and puts.
How Are Calls And Puts Different?
When you want to own a stock like Facebook, you begin the trade by buying shares. But when you trade calls or puts, you are not limited to simply buying options. In fact, you can start a trade by selling options too!
So, you can both buy call and put options and you can sell call and put options to begin trades.
Depending on your outlook for a stock’s share price, each option trade has its merits.
When you expect stocks to rise, you can buy call options or sell put options.
And when you think stocks will fall, you can buy put options or sell call options.
But why would you buy calls vs sell puts? And why buy puts vs sell calls?
Here’s the short answer…
|Option Type||Expectation For Stock Movement|
|Buy Call||Stock will rise a lot|
|Sell Put||Stock will rise a little or stay flat|
|Buy Put||Stock will fall a lot|
|Sell Call||Stock will fall a little or stay flat|
The bottom line is if you expect a stock to soar higher, buying calls will make more money than selling puts.
And if you expect a stock to decline in price, buying puts will make more money than selling calls.
How Much Can You Make Buying & Selling Options
When you buy call and put options, you continue to make money as the underlying stock rises or falls respectively.
However, when you sell calls or puts, the most you can make is a fixed amount called the option premium, which you receive at the beginning of each trade.
How Much Can You Lose Buying & Selling Options
Another big difference is the risk levels you take on when buying options vs selling options.
|Buy Call||Limited to what you pay for the option|
|Sell Put||The lower the stock goes the more you lose|
|Buy Put||Limited to what you pay for the option|
|Sell Call||The higher the stock goes the more you lose|
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Calls vs Puts: Rights & Obligations
When you buy options vs sell options, you will either enjoy certain rights or take on certain obligations.
For example, when you buy a call option, you pay for the right to buy the underlying stock at a fixed price for a certain time period.
Rather than shelling out $30 per share to buy a stock, you could pay $2 for a call option, and if the share price were to rise to $40, you could exercise your right to buy the stock for $30!
Similarly when you buy put options, you could pay $2 per share to buy a put option on the stock trading at $30 per share and, if it fell to $20 per share, exercise your right to sell the stock at $30 per share – even though it is trading in the market at $20!
Obligations When Selling Call Options
However, when you sell options, those rights are replaced by obligations. For example, when you sell a call option, you may be obligated to sell stock if the share price were to rise above a certain fixed level agreed upon at the start of the trade.
Because you incur this obligation when selling calls, it is usually smarter to own stock before selling calls, otherwise the strategy is labeled as a naked call.
So, if the share price were to rise above a certain level, and you were obligated to sell the stock, you would have shares to sell. If you didn’t own the shares originally, your broker would place short stock in your account.
|Type of Option||Rights & Obligations|
|Buy Call||Right to buy stock|
|Sell Put||Obligation to buy stock|
|Buy Put||Right to sell stock|
|Sell Call||Obligation to sell stock|
How To Get Paid To Buy Stocks At Lower Than Market Prices
When you sell put options, you may be obligated to buy stock if the share price were to fall below a certain threshold price.
Selling puts is a popular way to get paid to agree to buy stocks at lower prices.
For example, you could decide to sell strike $25 put options on a stock trading at $30 per share.
If the stock were priced above $25 at options expiration, you would keep the option premium collected when selling the puts.
However, if the stock fell to say $20 during the time period before the options expired, you would have a contractual obligation to buy the stock at $25 per share.
Why would anyone agree to this?
Selling Puts vs Buying Stocks
When you compare two scenarios when the trade began, you will see the attraction of selling puts.
On day one, you could buy stock for $30 per share but if it fell to $20, you would lose $10 per share.
Or you could sell puts that obligate you to buy stock at $25 per share and, if the stock fell to $20 per share, you would lose just $5 per share minus whatever premium you received selling puts.
So, your loss is lower when selling puts at strike prices below the current share price compared to buying the stock in the market today.
You may then ask why buy stocks at all? Why not always sell put options?
While it is better to have sold puts when share prices fall because losses are lower than buying stocks at the outset, more money is made buying stocks vs selling puts when share prices rise.
If the stock rallied to $40 from $30 per share, the stock buyer makes a $10 profit while the maximum the put seller can profit is the premium collected.
Do you have a good understanding of the differences between call options vs put options? Have you traded options before, what trading tips can you share? Tell us in the comments below.
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