Monday, 13 October 2014

Is the Long Call Option the Same as the Short Put option?

Long calls are not the same as short puts. Buyers of option contracts are long, while sellers or writers of option contracts are short. Call and put options give you the right to buy or sell the underlying securities at specified prices, known as strike prices, before predetermined expiration dates. Long and short option strategies have different risk-return profiles, with downside risk usually limited for long positions.
Basics
The relationship between strike prices and market prices determines profits and losses. A long call is profitable when its strike price is below the market price of the underlying stock, while a long put is profitable when its strike price is above the market price. The reverse is usually true for short calls and puts. You pay a premium, which is the market price, when you open or buy an option contract, and you receive the premium when you sell or close an option contract.
Long Call
You would typically buy a call if you have a bullish outlook on the stock. If the market price is above the strike price before expiration, you can exercise your right to buy the shares at the lower strike price and sell them at the higher market price, or you can trade the options at a profit. If the strike price is above the market price, you could let the options expire worthless and lose your entire investment, or you could close out the option position and cut your losses. The maximum profit is unlimited because the share price could theoretically keep rising. The maximum loss is the premium paid for the options. Long calls can provide substantial gains with limited downside risk.
Short Put
Shorting a put means writing or selling a put option contract at a particular strike price. You would write a put if you are neutral to moderately bullish on the stock or if you would not mind buying the stock at a certain price. You would receive the premium when you write each contract, but you could be assigned if the stock price trades below the strike price. This means that you have to buy the shares at the specified strike price when the buyer of the put option contract decides to exercise his right to sell the shares. Your maximum profit is limited to the premium. Your maximum losses could be larger but limited to the strike price minus the premium because the stock could theoretically become worthless. There is also an opportunity loss if the stock rallies substantially higher than the strike price.
Example
If you buy a long call with a $20 strike price and the stock price rallies to $25, you are in a net profit position of $5 per option contract, minus the premium and trading commissions. However, if the stock price stays below $20, your calls could expire worthless. If you write a put option with a $20 strike price, you could be assigned if the stock drops below $20 but not if it trades above $20 before expiration.

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