When it comes to options trading, strategies and techniques can quickly become complicated.
If you do not understand the ins and outs of options trading strategies, it is easy to make the wrong decision and lose money.
David Jaffee of BestStockStrategy.com has taught more than 1,500 students how to trade options while mitigating risk. He has taught both beginning traders and advanced traders.
Even if you are brand new to trading, you are probably familiar with the terms “put options” and “call options.”
Options are contracts that allow the buyer to buy or sell the underlying asset prior to the expiration date at a specific strike price.
As derivative investments, the price movements of call and put options are linked to another financial product, or an underlying.
But how do call and put options differ?
Keep reading to learn more about call and put options, including how to become successful at trading options.
What is a put option?
If you expect the price of an underlying to decrease during a certain time period, you buy a put option.
Put options are contracts that enable the buyer to sell the underlying asset at the chosen strike price.
The put option can be sold at any time until the expiration date.
You can find put options for assets like stocks, indexes, and commodities.
If the price of the underlying asset falls, the put option value usually increases. If the underlying asset price increases, the put option typically loses value.
The price of put options can be impacted by a variety of factors, including the price of the underlying asset, the strike price of the option, time decay, volatility and interest rates.
Traders use put options for hedging or speculating on downside price action.
Put options are also used for risk management and for hedging purposes.
As the expiration date of a put option gets closer, time decay accelerates and the put option’s value decreases.
Buying a Put
If you buy a put option, you can sell the stock at the strike price before the expiration date.
Traders pay a premium for the right to sell the stock.
Buyers usually make money when the underlying asset’s price falls below the strike price.
Selling a Put
If you sell a put, you collect option premium, which, in my opinion, is a better way to invest.
While the income from writing put options is limited compared to other trading strategies, the trade provides a positive expected outcome where the seller expects to profit.
Selling put options is a great way to earn income while minimizing your risk.
Selling options, and collecting premium, is very similar to an insurance company. Insurance companies sell policies and profit from the collected premium.
At BestStockStrategy.com, we SELL options. The primary reason why we sell options is because the expected volatility is almost always higher than the actual volatility.
What happens during times when the expected volatility is lower than the actual volatility? We roll / manage the positions and are protected by trading vertical credit spreads.
Or, we take ownership of the stock and participate in the upside.
What is a call option?
Like a put option, a call option is a financial contract.
A call option buyer can buy an asset at a certain price before the option’s expiration date.
The owner of a call option can buy a certain amount of an underlying asset, but they are not obligated to do so.
One call option contract provides the buyer with the right to purchase 100 shares of a stock.
If the price of the underlying asset increases, the buyer of the call option can earn a profit.
If the price of the underlying asset is below the strike price at the time of expiration, the call buyer loses their initial premium.
The premium of the call option is the maximum amount a trader can lose.
Buying a Call
When buying a call option, you pay an option premium.
If the price of the underlying asset increases above the strike price, you can earn a profit.
If the price of the underlying asset is below the strike price at expiration then the option expires worthless and you'll lose the premium that you paid.
Selling a Call
Selling a call option is similar to selling a put option.
The call writer collects the premium from the buyer and keeps it.
While the potential for profit when buying a call option is unlimited, it is a risky move because most options expire worthless.
Like selling a put, selling a call provides a high probability of profit.
As stated previously, we like to sell options, instead of buying them.
How to Make Money with Put and Call Options
Buying and selling call and put options are common options trading strategies.
With an unlimited potential for profit, many traders are attracted to buying call or put options.
However, the risk is also great with these strategies because they have a negative expected outcome.
Not only do you have to be right directionally when buying options, but the magnitude of the move also has to exceed the expected volatility in order for you to profit and make money.
David Jaffee teaches his students how to sell option premium, which many believe is the best and safest options trading strategy.
Selling options provides a high win rate, and trading credit spreads allows you to minimize your risk to maximize your profits while earning a consistent income from options trading.
Learn more at BestStockStrategy.com with David Jaffee’s comprehensive options trading course.
Frequently Asked Questions (FAQs)
What is better put or call option?
Since the stock market has a positive bias, it's generally better to sell puts.
You can also buy calls during market extremes when the market is highly oversold.
Additionally, it's smart to buy puts during periods of euphoria when the VIX is low.
What are the four types of options trades?
You can either:
1) Buy a call
2) Sell a call
3) Buy a put
4) Sell a put
What are level 4 options?
Level 4 options allows you to sell naked puts and calls. You can apply for level 4 with your trading broker.
Should I buy calls?
I believe that buying LEAPS is a good strategy during market extremes, when you believe that stocks are oversold.
VIX measures the volatility on the S&P 500 index. VIX provides insight into the expected volatility in the stock market.
When VIX is high, options prices will also be high because investors believe that future volatility, and risk, are elevated.
When VIX is low, then option premium, and prices, are low because investors believe that risk is low.