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As an investor, you might have been considering trading options, but you have not been able to take that leap because you’ve been thinking of the things involved, like if options are a high or low risk and if the call or put options are good at all.
Call or put options can be good or bad depending on how you use them. If you invest every dime in a put or call option hoping that a stock will go up or down then those options could be really bad! However, if you use options to increase your leverage or even to hedge your risk then they can be very good.
As with other types of investing, call/put options have their risks, but they are also helpful to the investor. For example, they can deliver higher percentage returns. However, call/put options can be harmful if you don’t have adequate knowledge about how to use them effectively.
In this article, I will go into why you should consider trading call/put options, the difference between call/ put options, the best choice between call/ put options, and some of the basic options strategies. Let’s dive right in.
Difference Between Call and Put Options
Call options are a contract between two parties. Here, the option buyer purchases the right but not an obligation to buy an asset from the call option seller at a specific price over a fixed period.
With call options, the option buyer gains his profit when and if the asset he bought price increases. If the opposite happens and the asset decreases in price, the call buyer loses money and will have to sell the call option at a loss or even have it expire worthless.
Put options, on the other hand, are the opposite of call options. In put options, the asset holder has the right to sell an asset or a specified amount of an underlying security at a fixed price over a specific time frame.
Unlike the call option, where the profit lies in the price increase of the asset, a put option becomes more valuable when there’s a decrease in the underlying stock price.
Similarities Between Put and Call Options
- In put and call options, value decays with time, meaning they are both sensitive to time expiration.
- Both call and put options are high risk, and investors can have a significant loss while trading either of the two if they are not careful.
- The two types of options allow you to earn. Whether you buy or sell, you have the potential to earn.
- Call and put options give you the right to buy or sell stock at a fixed price over a specific period.
- Call and put options require you to pay a premium fee which you risk losing if you don’t exercise the option or if you don’t sell it prior to expiration.
When Should You Consider Call or Put Options
Options are advantageous; they require less financial commitment, and they can deliver high percentage returns, but as with any other high rewarding venture, there is also high risk.
In both call and put options, if the asset’s price does not move in the direction that will be advantageous to investors and increase profits, they’re going to run at a loss. However, if the reverse happens and the asset’s price moves in a direction the investors want or expect, they earn significant profits.
So, it is okay to trade options; however, before doing so, it is advised that investors have adequate knowledge of how they work; this way, the losses should be less frequent and the profits can be achieved more reliably.
Basic Options Strategies
No one should go into options trading without the necessary knowledge. Some people would go into it because of the incredibly high possible returns without doing the appropriate research. But to get the best returns out of options trading, you need to know and understand some different options strategies.
This way, you minimize loss and maximize your profits. Some of the options strategies you can employ include the following:
In married put strategy, also known as protective put, underlying stock shares are purchased by an investor who also buys put options of equivalent number. A married put is best used when an investor is bullish on a stock.
The married put strategy can be used to guard against a price depreciation of stocks, so it’s more like a capital preservation strategy than a profit-making strategy.
The profit from utilizing the married put strategy is lower compared to just owning the stock.
In a covered call strategy, an investor who has been holding on to an asset, hoping it would increase in price, sells call options on that same asset to generate an income. With this method, the investor owns an equivalent amount of the underlying stock.
The covered call strategy generates revenue and lowers the risk of being in the stock alone. A bullish or bearish investor can do well not to write or sell this option and keep holding on to the asset instead.
However if the market trades sideways this strategy allows you to increase your returns.
Bear Put Spread
A bear put spread strategy is a form of a vertical spread. Here, the investor purchases put options for a specific price and, at the same time, sells the put options at a lower strike price.
In a bear put spread strategy, an investor hopes for a decrease in the cost of the asset.
This strategy is done by buying an out-of-the-money put option and at the same time they write/sell an out-of-the-money call option. When a long position in the stock has experienced gains, the protective collar strategy is used.
In a defensive collar strategy, the underlying asset and expiration date must be the same.
I love to call the long put a “based on belief strategy” because an investor buys put options with the belief that the underlying stock’s price will go lower rather than rise before the expiration date, in essence, wagering on the decrease of the strike price.
The risk for using the long put strategy is limited to the put option price no matter how high the stock is trading on the expiration date.
As with the long put strategy (mentioned above) the investor using this strategy believes that the stock will go in a specific direction before the option expires. In the case of a call the investor expects the stock price to go up.
As with a long put the only money at risk with a long call strategy is the amount paid for the call. So if you pay $1 for the call then you are risking $100 (since options are sold in lots of 100). The most you can lose is that $100 you paid for the long call.
Call/ Put options can be profitable for the savvy investor; otherwise, no one would use them. So, if you’ve been thinking of trading options for a while and have done your due diligence, you can go ahead and start trading.
Just make sure you have ample information and knowledge on how Call/Put options work to prevent a drastic and continuous loss.