Call vs Put Options Explained
Options are one of the most popular trading strategies on the market, and for good reason, options can offer traders a safety net within their trades. And, if you know anything about the market you’ll understand that is a rare thing. So, let’s get into what options are and the different types you may encounter throughout your trading career.
Options trading can be a complex form of trading even with their rise in popularity, there are still risks associated that could be detrimental to your trading career. However, Simpler Trading has you covered, we offer guidance and mentorship in our Option Gold Room. Become a member today and join us in the live trading room and trade alongside professional traders. So that way you’ll never trade alone again.
Video Guide to Put and Call Options
What are Options
Options are contracts that are written by a seller for a predetermined price, by a specific date. In addition, every option contract equals 100 shares of a particular stock. For example, If you buy 1 option contract on Amazon (AMZN), your option contract represents 100 shares of Amazon stock. The price of an option depends on the price of the underlying stock and changes as the stock price changes.
Options can act as insurance for the trader. If you hold stock in Apple (AAPL) and you think the stock might go down, you can buy a put option to offset some of your losses in the stock. Additionally, when buying options, if your position is not profitable, then you don’t have to exercise your right to buy or sell the stock, you can simply let the option expire, and the only loss was the premium you paid to buy the option. There are two basic types of options that are available to traders, and they are call and put options.
Each option contract has a strike price and an expiration date. The strike price is the stock price at which the option can be exercised. If you buy a call option with a strike price of $20, you have the right to buy the stock at $20, even if the stock goes up to $30 after you buy the option. This is how profits are made. Below you’ll see the different types of call and put options strategies that traders tend to use.
Types of Call Options
- Long Call Options – are considered a standard call option, where the buyer has the right but not the obligation to buy the stock in the future at a predetermined price before the call option expires. However, most traders don’t use their options contracts to buy stock, they buy the option and sell it at a higher price. A trader would be interested in buying a long call option if they have a bullish take on the market and feel a stock will increase over time. The price of the option increases as the stock price increases.
- Short Call Options – are not only riskier but are also a bearish take on a market price. Short call options allow the trader to sell a call option to a buyer. But this binding agreement obligates the seller to sell their position if the call is exercised by the buyer. If you sell a put option and the buyer exercises the option, your broker will take 100 shares of the stock (per contract) and give it to the option holder. Your account will show that you own a negative amount of shares of stock. If you don’t have enough money in your account, you will have to deposit more money to cover the transaction. This is called selling options “naked” and can be very risky.
Types of Put Options
- Long Put Options – gives the buyer the right but not the obligation to sell an underlying asset in the future at a predetermined price and date. A trader who is interested in buying a put option has a bearish take on the market and feels the stock they are interested in will decrease in price. If the stock loses value, the trader makes a profit. Again, most traders don’t exercise their options contracts, instead, they buy the put option, and sell it when it gains value, profiting from the difference.
- Short Put Options – this type of option is when a trader sells a put option contract and takes in a premium for selling it. The seller would have a bullish take on a position and hope the option loses its value, letting the trader keep the premium they took in when they sold the option. However, a short put obligates the seller to buy 100 shares of stock per put option if the put options buyer exercises their position. This type of trading can have a tremendous amount of risk associated with it, as losses can hypothetically be unlimited.
Difference Between Call VS Put Options
If you think a stock is going up, buy a call option. If you think a stock is going down, buy a put option. You can also sell calls, which means you think the stock will fall, or sell puts, which means you think the stock will go up. Selling options “naked” is extremely risky and can result in losses beyond what you have in your brokerage account. Traders have to understand the market conditions and whether or not they are in a bullish or bearish market.
Example of a Call Option
Let’s say you’ve done a lot of research on a particular stock and think the stock price will rise. A trader may be compelled to buy a call options contract for that particular stock, they would pay a premium for the right to buy but not the obligation too for a specific stock. You could buy a call option for the stock, enabling you to profit as the stock price rises, without actually buying the stock. This is a lower-priced way to participate in the market because you don’t need cash to buy 100 shares of stock.
There are a few scenarios you can take with an option position. Scenario one: if the stock goes up past the strike price, the trader can execute their option to buy the stock for a profit. Scenario two: If the stock never goes past the strike price and goes down lower, the trader can allow the options contract to expire, and the only loss to the trader is the premium that was paid to the seller. Scenario one: if the stock rises in value and you would like to buy shares of the stock, you can exercise your option. You need to have enough money in your account to buy the shares. Scenario two: if the stock rises in value, your option contract also rises in value, so you could sell the option for a profit. Scenario three: if the stock price falls, you can either sell your option to salvage what value it has left, or let it expire. If you let it expire.
Example of a Put Option
If you have a bearish take on the market and think the stock is trending down, then you could buy a put option on the stock. You would then pay a premium for the right but not the obligation to sell that stock. Remember, each option contract has a strike price and an expiration date. If the stock goes lower than the strike price, the trader can sell their option position for a profit.
Advantages of Options Trading
There’s a reason why options are so popular and it’s because it helps average traders trade at a higher level in the market. Take TSLA for example, at any given moment TSLA can cost hundreds of dollars per share. And if an average trader were to buy 100 shares, it would cost thousands of dollars for a trader to execute that trade. However, with options, you can gain 100 shares of TSLA by merely paying the premium of an option.
Traders can also hedge their trades with put options. For example, let’s say a trader is in a stock position, and they purchased shares of a stock for $20 per share. In this case, the trader wants the stock to go up, but if they are unsure if it will rise in price they can buy a put option to protect their portfolio. For instance, if they buy a put option for $15 and the price of the stock drops all the way to $10, they can sell their put options for a profit, offsetting some of the losses in the stock.
Here at Simpler Trading, we understand that Options can be a very complex way of trading, but we have experienced professionals that can help. Sign up today and become a member, and join us in our Options trading room, where you never have to trade alone again.
Call and Put Options FAQs
A: Stocks are an asset that allows you to have a small percentage of ownership of a business that you bought into. An option is merely a contract between a trader and a buyer that gives the buyer the right but not the obligation to exercise their position.
A: If you want to invest in a company and have a long-term view of a stock. You may be able to reap the benefits of dividends and long-term gains. However, if you are a trader who has a bullish or bearish outlook on a particular position. And, you have a good idea of how to trade that stock, then options may be better suited for you. Both types of strategies require a great deal of research.
A: That truly depends on your account, skill level, and risk tolerance. Both forms of trading can be a way to make great profits. However, the answer is subject to each trader. There have been traders who have done very well in both avenues of trading.
Originally Published: July 23, 2018, 9:59 PM