Buying a Call vrs Selling a Put (Basic Options 13)

Buying a Call vrs Selling a Put (Basic Options 13)

This is the first of two videos where we look at buying a Call Option versus Selling a Put Option

Vid Text:



Hello and welcome. In this video, we will look at buying a Call Option versus selling a Put Option.



For a stock trade, If a trader thinks that the stock is going up, they have one choice-, they can buy the stock, and if they think the price is going down, they have one choice- they can short the stock.



Option traders have two choices. if they think the price of a stock is going up, they can buy a Call Option, or they can Sell a Put Option.

If they think the price of the stock is going down, they can buy a Put Option or they can sell a Call Option.



Let's say that a trader is bullish and let's look at 2 different choices for Call Options an option trader could buy, and 2 different Put Options he could sell. For this example, I am using SLV the silver ETF, and I am using options that are out of the money. At the time of making this video, SLV is currently trading for $20.65 a share.



For 58 cents a share, the trader can buy a Call Option with a $21 Strike Price that expires in about a month. This locks in a pre-set buy price of $21 for an upfront cost of 58 cents a share. If the price of SLV rises over $21 a share, the trader can buy it for $21, sell it at the current price and make the difference. However, for the trade to be profitable, the price of SLV needs to rise not just above $21, but above $21.58 to cover the cost of the Option. If the price of SLV does not rise above $21, then the option expires worthless and unused.



For 40 cents a share, the trader can buy a Call Option with a $21.50 Strike Price that also expires in about a month. If the price of SLV rises over $21.50 a share, the trader can buy it for $21.50, sell it at the current price and make the difference. However, for the trade to be profitable, the price of SLV needs to rise not just above $21.50, but above $21.90 to cover the cost of the Option. If the price of SLV does not rise above $21.50, then the option expires worthless and unused.



So looking at these two choices-

The option with the 21.00 Strike Price costs more up front than the option with the $21.50 Strike Price, meaning that there is a larger amount at risk for loss, but the price of SLV doesn't have to climb as high for the trade to be profitable, meaning that there is a greater probability or chance of occurring.

The $21.50 Strike costs less up front, so there is less at risk, but the price of SLV has to climb higher, meaning there is less probability or chance that this trade will be profitable.

The difference in these two options is the risk versus the probability that the trade will be profitable.



Instead of buying a call option, the trader could choose instead to sell a Put Option.



When a trader sells a put option, they are agreeing to buy 100 shares of stock from the person they sold the Put Option to for a pre-set buy price, in other words the Option Strike price, if the price of the stock is lower than that Strike Price.



The person that bought the put option from the Trader is buying the right to sell the Trader 100 shares of stock at that pre-set price. By selling a put option, a Trader is agreeing to buy the stock for that pre-set buy price if the stock price drops down below it.



The trader could choose to sell a Put Option with a $20.50 Strike for 65 cents a share. This means that the trader is selling his commitment to buy SLV for $20.50 if the price of SLV falls below $20.50, and he was paid 65 cents up front to do this. If the price of SLV remains above $20.50 per share, the Put Option expires worthless and the trader keeps the 65 cents premium he was paid for the option.



If the price of SLV drops below $20.50 a share, the trader is obligated to buy SLV for $20.50.



However, he was paid 65 cents a share up front for the option, so he is obligated to buy SLV for $20.50, and he was paid 65 cents up front for his commitment, so the trader does not lose money unless the price of SLV drops, not just below $20.50, but below $19.85.



If the price of SLV drops below $19.85, the trader’s loss is the difference between the $20.50 Strike Price and the current price that is below $19.85, minus the 65 cent premium he was paid up front



The trader could choose to sell a Put Option with a $20 Strike for 40 cents a share. This means that the trader is selling his commitment to buy SLV for $20 if the price of SLV is below $20, and he was paid 40 cents up front to do this. If the price of SLV remains above $20 per share, the Put Option expires worthless and the trader keeps the 40 cents premium he was paid for the option.





If the price of SLV drops below $20 a share, the trader is obligated to buy SLV for $20.



However, he was paid 40 cents a share up front for the option, so he is obligated to buy SLV for $20.00, and he was paid 40 cents up front for his commitment, so the trader does not lose money unless the price of SLV drops, not just below $20, but below $19.60.





If the price of SLV drops below $19.60, the trader’s loss if the difference between the $20 Strike Price and the current price that is below $19.60, minus the 40 cent premium he was paid up front



So looking at these two choices- If the trader sells the $20.50 Strike, he is paid more up front than he is paid if he sells the $20 Strike, so his potential profit is greater. However, the higher Strike Price means that there is a greater probability or chance that he will take a loss. The difference in the two options is the potential profit versus the probability that the trade will take a loss.



So that is an example of 2 Call Options that a trader can buy, and two Put options that a trader can sell on a stock. In the next video, we will continue the discussion by comparing buying the $21.50 Call Option to selling the $20.00 Put Option. See you then.

by Tekmnd via InformedTrades