Last updated on September 18th, 2022 at 08:55 am
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Both option buyers and option writers can profit from options trading. This is because options enable you to make potential profits both during volatile times and when the market is relatively quiet.
But how exactly do call/put options payout?
Call options payout when the underlying security rises above the predetermined price or strike price before expiry. On the other hand, put options earn money when the asset price falls below the agreed-upon price before the expiration date.
You can make money on the puts or calls that you purchased by exercising them or by selling them prior to the expiration date. Most people who trade options will want to simply sell their options for a profit so they will never exercise them.
So your profit is made when you sell the call or put at a higher price than what you paid.
In this article, you will find more information on how you can make money with both call and put options.
How To Make Money With Call/Put Options
Options typically payout at expiry if the strike price is above or below the market (depending on whether you bought calls or puts). However this is only true if you hold the option’s until expiration.
You can also make money with options by simply buying and selling them long before they expire.
Whatever the prevailing market conditions, asset prices are dynamic, always in constant motion. Fortunately, there is always an options strategy to leverage the movements. Let’s explore these strategies a bit further.
How To Make Money Buying Calls Or Selling Puts
Call option buyers stand to earn a profit if the underlying security, such as a stock, moves above the pre-agreed strike price before expiry. On the other hand, put option buyers profit when the price of the security falls below the strike price before the expiration date.
As mentioned earlier, selling prior to expiration is another way to make money on your calls or puts. Conceivably you could make money by just holding an option for a few seconds or minutes!
When buying calls, the amount of profit depends on several factors:
- The difference between the asset price (market rate) and the option strike price at the time of closing the option position or at the expiration
- The deal size
- The number of options held
For a put option seller, the potential profit to be made is limited to the premium the option seller receives for writing the put.
As a call option writer, you make money if the asset underlying the option remains below the agreed-upon price. Also, you can exercise your call options at any time, either before or on the expiration date. In contrast, upon writing a put option, you stand to profit if the asset price remains above the predetermined price.
Your earnings as an option writer (or option seller) are limited to the premium (the amount paid by the buyer for the option) you get for writing the option. In other words, the most that a put option seller can make is whatever they were paid when they sold that put no matter what the stock price doesn’t
However, when you own a call or put option, your profit potential is virtually unlimited, while your total loss is capped to the premium you paid.
Thus, whichever options strategy you choose to employ, you stand to make money from several market conditions ranging from bull to bear and sideways markets.
One significant thing to note is that owning a stock is more expensive than owning a call option. This makes it more profitable to own a stock option than the individual stock, especially when you know the stock price is about to rise.
As such, trading call options can be way more profitable than trading stocks.
How To Make Money From Downward Movements Selling Calls or Buying Puts
You can make money even when price movements are moving downwards by selling calls or buying puts. In this case, the call writer’s upside is limited to the option premium while the put buyer enjoys a potentially unlimited upside, though with downside capped to the option’s strike price (since the stock can’t go below zero).
The put buyer profits if the underlying security’s market price declines, with the profit amount dependent on how far the market price falls below the strike price before expiration (or before they sell the put).
When To Buy a Call Option
Generally, a stock price can go up, down, or stay as-is. A call option appreciates in value as the stock moves up. Options traders buy call options on the premise that their market price will go up, while call sellers believe the price will fall or stay the same.
If you strongly believe that the price of a stock is set to move upwards, you can profit from it by making two kinds of trades: you can either buy call options or write put options on the particular stock.
It’s possible to make remarkable returns when you are certain that a stock price will increase considerably in a short time. However, even if the stock price fails to move as expected and falls instead, you cannot lose more money than the amount of your initial investment on the call option, no matter how far the stock falls in value.
How To Cash In On A Put Option
Put options rise in value as a stock falls in price. Their appeal lies in the fact that a small move in the stock price can cause them to appreciate fast, allowing you to make big gains in a relatively short time frame.
When you want to cash in on a put option, you will purchase the option with the expectation that the price of the underlying stock will decline before expiration. As such, you earn money when the option price moves up as the stock price moves down.
Alternatively, you may decide to exercise your option to sell the stock at the strike price if you own it. However, most people who buy put options just buy them for the appreciation not for actually trying to sell shares of their stock.
Deciding Whether To Buy Or Write/Sell Options
An options buyer stands to make a considerable profit if a stock moves significantly beyond the predetermined strike price. The options buyer pays a premium for the option but stands to make a potential profit should the market move favorably.
This profit can be unlimited and depends on how high the stock rises (or falls in the case of a put). What’s more, the option cannot generate a loss beyond the purchase price paid if the stock fails to rise above the option strike price.
On the other hand, an options writer stands to make a much smaller return if the option trade turns profitable since their return is limited to the premium. This is the case regardless of how much the stock goes up or down. As a result, writing options often work out to be profitable because the odds generally favor the option writer.
The profits from selling calls or puts are much smaller than those that an option buyer can get however they are also much more likely to happen since most options expire worthless.
Many traders believe options to be highly risky. While this can be true if used incorrectly, call and put options can also allow you to make significant profits if used appropriately.
The best thing to do is to learn to limit your risks while making money on a stock’s rise or fall.