Buying A Put V/S Selling A Call: How To Decide

Many F&O traders normally are confused between buying a put option versus selling a call option. Broadly both are bearish strategies and the difference between a call and put option is that while the former is a right to buy the later is a right to sell. Obviously when you buy an option your risk is limited to the premium you pay. That is because your loss is limited to the premium paid while your profits can be unlimited. On the other hand, when sell an option, your income is limited to the option premium received but the losses can be technically unlimited. Let us understand the difference between a call and a put with example. Let us also understand how to trade in call and put options, both on the buy side and the sell side.

Call and put option with a live example
 Let us assume that the current market price of Tata Steel in the spot market is Rs.695/-
ContractCall PremiumPut PremiumITM or OTMNovember 680 Call24.00-ITMNovember 680 Put-7.00OTMNovember 720 Call7.50-OTMNovember 720 Put-28.20ITM  
An In-the-Money (ITM) option is one that has intrinsic value and time value. Take the case of the 680 Call Option on Tata Steel. The Call is currently quoting at Rs.24, of which Rs.15 is explained by the intrinsic value of call option (695-680). The balance Rs.9 is the time value. In case of the 680 put, the intrinsic value is zero and so the entire Rs.7 is explained by time value of money.
Let us come to the 720 strike. The 720 Put is currently quoting at Rs.28.20. Of this Rs.25 is explained by intrinsic value (720-695) and the balance Rs.3.20 is explained by time value of money. In case of the 720 call the entire Rs.7.50 is the time value of money.
What determines the economics of buying a put versus selling call?
As we have already seen, you buy put option when you expect sharp downsides in the stock. Therefore, you bet by limiting your risk to the option premium and play for the downside in the stock. You sell call option when you expect that the upsides for the stock are limited. You are indifferent to whether the stock is stable or goes down as long as the stock does not go above the strike price. Before getting into how to trade in call and put options, let us first understand the difference between call and put positions with the example above.
Let us now consider 2 investors viz. Alpha and Beta. Alpha is an aggressive investor who believes that with the metals cycle already overpriced, Tata Steel price should correct. He expects the price to correct to Rs.640 in the next 1 week. He can sell the Tata Steel 680 call and get a maximum profit of Rs.24, which is a good profit on his margin. However, Alpha is taking on a very huge risk here. Since Alpha has sold the 680 Call at Rs.24, he is only covered up to Rs.704. Any price above that will result in unlimited losses for Alpha. The better option will be buying the 680 November Put option. If the price touches Rs.640, then he makes a profit of Rs.33/- (40-7). In a worst case scenario if the Tata Steel stock goes up to any level, his loss is limited only to Rs.7/- share.
Now, let us consider the case of Beta who is more conservative. Beta is of the view that the stock may be hovering in a range. While downsides are open, its upside is limited to Rs.720. The best option for Beta is to sell the 720 call. Buying the 720 put may be too expensive and buying the 680 put may be too out of the money. Selling the 720 call will give him a premium of Rs.7.50 and serve his view.
Buying a put option versus selling a call option: How to decide?
Your decision whether you should buy a put option or sell a call option will be broadly guided by the following 4 considerations:

Are you having an affirmative view on the stock or index going down? In that case it makes more sense for you to buy the put option. Your downside risk will be limited to the option premium paid and your profits in case the stock falls will be unlimited.

Are you having a cautiously non-affirmative view on the stock? In this case you are only confident that the stock price is unlikely to rise beyond a point. You are indifferent to whether the stock price goes down or stays stagnant at current levels. In such cases, it makes eminent sense to sell the call at the strike where you believe the stock to top out. You can also sell a lower call for higher premium but that is taking on unnecessary risk.

Can you pay the margins for the trade? When you buy a put option, your total liability is limited to the option premium paid. That is your maximum loss. However, when you sell a call option, the potential loss can be unlimited. Hence your margining will be exactly like how the margins are imposed on futures. Be prepared for higher capital outlay in this case.

Lastly, are you playing for a rise in volatility or fall in volatility in the market? If you are playing for a rise in volatility, then buying a put option is the better choice. However, if you are betting on volatility coming down then selling the call option is a better choice.

How to trade put and call options is all about knowing the difference between call and put options in terms of risk and return potential. Your choice can actually be a simple one.

BEARISH MARKET TRADING STRATEGIES

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When your outlook on an underlying security is bearish, meaning you expect it to fall in price, you will want to be using suitable trading strategies. A lot of beginner options traders believe that the best way to generate profits from an underlying security falling in price is simply to buy puts, but this isn't necessarily the case.

Buying puts isn't a great idea if you are only expecting a small price reduction in a financial instrument, and you have no protection if the price of that financial instrument doesn't move or goes up instead. There are strategies that you can use to overcome such problems, and many of them also offer other advantages.

On this page we discuss the benefits of using bearish options trading strategies, and some of the disadvantages too. We also provide a list of the ones that are most commonly used.

·         Why Use Bearish Options Trading Strategies?

·         Disadvantages of Bearish Options Trading Strategies

·         List of Bearish Options Trading Strategies

Why Use Bearish Options Trading Strategies?

First, we should point out that purchasing puts is indeed a bearish options trading strategy itself, and there are times when the right thing to do is to simply buy puts based on an underlying security that you expect to fall in price. However, this approach is limited in a number of ways.

A single holding of puts could possibly expire worthless if the underlying security doesn't move in price, meaning that the money you spent on them would be lost and you would make no return. The negative effect of time decay on holding options contracts means that you'll need the underlying security to move a certain amount just to break even, and even further if you are to generate a profit.

Therefore, buying puts options is unlikely to be the best strategy if you are anticipating only a small drop in price of the underlying security, and there are other downsides too. This isn't to say that you should never simply buy puts, but you should be aware of how some of the downsides can be avoided through the use of alternative strategies.

There is a range of trading strategies suitable for a bearish outlook, and each one is constructed in a different way to offer certain advantages. An important aspect of successful trading is to match a suitable strategy to whatever it is you are trying to achieve on any given trade.

As an example, if you wanted to take a position on an underlying security going down in price but didn’t want to risk too much capital, you could buy puts and also write puts (at a lower strike) to reduce some of the upfront cost. Doing this would also help you offset some of the risk of time decay.

Another way to reduce the negative effect of time decay would be to include the writing of calls. You can even use strategies that return you an initial upfront payment (credit spreads) instead of the debit spreads that have an upfront cost.

Basically, bearish options trading strategies are very versatile. By using the appropriate one you cann't only profit from the price of the underlying security falling, but you also have an element of control over certain aspects of a trade like the exposure to risk or the level of investment required.

Disadvantages of Bearish Strategies

Although there are clear advantages to using bearish options trading strategies other than simply buying puts, you should be aware that there are some disadvantages too. Most of them usually involve a trade off in some way, in that there's essentially a price to pay for any benefit you gain.

 For example, most of them have limited profit potential; which is in contrast to buying puts where you are limited only by how much the underlying security can fall in price. While this isn't necessarily a huge problem, because it's reasonably rare for a financial instrument to drop dramatically in price in a relatively short period of time, it does highlight that to get an extra benefit (such as limited risk) you have to make a sacrifice (such as limited profit).

In some respects, the fact that there are a number of different strategies to choose from is a disadvantage in itself. Although it's ultimately a good thing that you have a selection to choose from, it's also something of an extra complication, because it takes extra time and effort to decide which is the best one for any particular situation.

Also, because most of them involve creating spreads, that require multiple transactions, you will have to pay more in commissions. In truth, though, these disadvantages are fairly minor and far outweighed by the positives. The fact is if you can become familiar with all the various strategies and adept at choosing which ones to use and when, then you stand a very good chance of being a successful trader.

List of Bearish Strategies

Below is a list of the more frequently used strategies that are suitable for when you have a bearish outlook. There's also some brief information about each one: including the number of transactions required, whether a debit spread or a credit spread is involved, and whether it's appropriate for beginners.

You can get more detailed information on each one of these by clicking on the relevant link. If you would like additional help in choosing a strategy, then you can use our selection tool which you can find here.

Long Put

This is a single position strategy that involves only one transaction. It's suitable for beginners and comes with an upfront cost.

Short Call

Only one transaction is required for this single position strategy, and it produces an upfront credit. It isn't suitable for beginners.

Bear Put Spread

This simple strategy is perfectly suitable for beginners. It involves two transactions, which are combined to create a debit spread.

Bear Call Spread

This is relatively straightforward strategy, but it requires a high trading level so it isn't really suitable for beginners. A credit spread is created using two transactions.

Bear Ratio Spread

This is complex and not suitable for beginners. It requires two transactions and can create either a debit spread or credit spread, depending on the ratio of options bought to options written.

Short Bear Ratio Spread

This is fairly complicated and not ideal for beginners. A credit spread is created and two transactions are involved.

Bear Butterfly Spread

The bear butterfly spread has two variations: the call bear butterfly spread and the put bear butterfly spread. It's not suitable for beginners; it requires three transactions and creates a debit spread.

Bear Put Ladder Spread

This requires three transactions to create a debit spread. It's not suitable for beginners due to its complexities.

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BANKBARODA 72 PUT  BOOKED PROFIT@ 1 BUY GIVEN @ 0.7 PROFIT OF 3510"

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INVESTMENT 17550 

RISK :: RETURN

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OPTION CALL PUT TIPS ROCKS

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BANKBARODA 75 CALL ACHIEVED TARGET 1 BUY GIVEN @ 0.7 PROFIT OF 3510

NIFTY 14500 PUT  ACHIEVED TARGET 45/55  BUY GIVEN @ 35 PROFIT OF 2250

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Some Popular Options Trading Strategies

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Options are one of the most exciting areas of the investing world because of their potential for huge gains. But to get started, you’ll want to know what options strategies are available, when they’re best suited to particular situations and what the risks and rewards are.

Options strategies come in a variety of flavors, but they’re all based on the two fundamental options: calls and puts. From these basics, investors can create a range of strategies that maximize the payout from a stock’s movement and savvy investors pick the strategy that’s best for how they expect the stock to perform.

Options trading strategies to consider

1.      The long put

2.      The long call

3.      The short put

4.      The covered call

5.      The married put

6.      The long straddle

7.      The long strangle

1. The long put

 The long put is an options strategy where the trader buys a put expecting the stock to be below the strike price before expiration.

Best to use when: The long put is a useful strategy when you expect the stock to decline and you want to earn a large upside. Traders will earn a significantly better return on their investment than by short selling the stock, so a long put could be a good substitute for shorting the stock directly. The long put also limits the short seller’s loss to the premium, while shorting the stock exposes the trader to uncapped losses.

Example of the long put: Reliance stock trades at $100 per share, and puts with a $100 strike price are available for $10 with an expiration in six months. One put costs $1,000 (one contract * 100 shares * the $10 premium).

Here’s the return at each stock price, including the cost to set up the position.

Stock price at expiration	Long put’s profit
$130	-$1,000
$120	-$1,000
$110	-$1,000
$100	-$1,000
$90	$0
$80	$1,000
$70	$2,000

Risk/reward: The long put can pay off significantly if the stock moves below the strike price before the option expires. In this example, the maximum return is 10 times the original investment, or $10,000. In general, the maximum value of the long put equals the total value of stock underlying the trade (the number of contracts * 100 * the strike price).

The risk for this potential upside is a complete loss of the premium paid for the put. But if the stock moves higher, making the put less valuable, traders often can salvage some of the value by selling the put, as long as it has substantial time to expiration.

2. The long call

With the long call, the trader buys a call expecting the stock to be above the strike price before expiration.

Best to use when: The long call is much like the long put, but it pays out when the stock rises. So if you’re expecting the stock to move higher, the long call is the way to go. The long call can earn a much higher percentage return than owning the stock directly.

Because the trader’s downside is limited to the option’s premium, the long call also could be a good strategy if the stock has the potential to move much higher but has the potential to move much lower too. If the stock falls, the option’s limited loss could be less than owning the stock directly.

Example of the long call: Reliance stock trades at $100 per share, and calls with a $100 strike price are available for $10 with an expiration in six months. One call costs $1,000 (one contract * 100 shares * the $10 premium).

Here’s the profit at each stock price, including the cost to set up the position.

Stock price at expiration	Long call’s profit
$130	$2,000
$120	$1,000
$110	$0
$100	-$1,000
$90	-$1,000
$80	-$1,000
$70	-$1,000

Risk/reward: The long call has uncapped upside as the stock moves higher, and that’s why this strategy can be a home run. If a stock rises, you can make many times your investment.

Like the long put, the risk here is that the investor could lose all of the premium paid for the call. However, if the stock moves lower — making the call less valuable — traders often can save some of the value by selling the call, as long as it has substantial time remaining to expiration.

3. The short put

In a short put, the trader sells a put expecting the stock to be higher than the strike price by expiration. This is similar to selling insurance against the stock falling below the strike price.

Best to use when: There are two good situations for the short put.

• If the trader expects the stock to be above the strike price at expiration, the short put is a way to generate income by pocketing the premium.
• The trader can use the short put to achieve a more attractive buy price on the underlying stock. If the stock doesn’t move below the strike price, the trader keeps the premium and can execute the strategy again. If the stock falls below the strike, the trader buys the stock at a discount to the strike price, using the premium to reduce the net price paid.

Example of the short put: Reliance stock trades at $100 per share, and puts with a $100 strike price are available for $10 with an expiration in six months. One put generates a total premium of $1,000 (one contract * 100 shares * $10 premium).

Here’s the profit at each price, including the cost to set up the position.

Stock price at expiration	Short put’s profit
$130	$1,000
$120	$1,000
$110	$1,000
$100	$1,000
$90	$0
$80	-$1,000
$70	-$2,000

Risk/reward: The short put’s maximum payoff is the premium received by the trader. The stock might fall well below the strike price, but all the short put earns is the premium. The maximum payoff occurs anywhere above the strike price.

The downside for the short put can be substantial, and the trader can be forced to add money in order to close out the trade if there’s not enough to purchase the stock at the strike price. The maximum downside occurs when the stock goes to zero. In this example, the put would lose $10,000 (100 shares * the $100 stock * the one contract), though the investor would still have the $1,000 premium. Short puts can be risky with limited upside.