How do you decide between locking in profit immediately or potentially reaping bigger gains later? 

Welcome to the conundrum of options trading, where your current choices—and decisions—shape your financial future.

In the world of trading, selling puts is like assuring a vendor you’ll buy their fruit at the end of the day if no one else does. While buying calls is like holding a voucher to grab the juiciest apple upon return, but only if you wish to.

Each has its rhythm for different market tempos, but which one suits you better?

This article will guide you through the intricacies of these strategies, highlighting their differences, advantages, and potential snags.

Let’s dive in. 

Exploring Selling Puts and Buying Calls

Selling puts and buying calls are two different fundamental options strategies, each having distinct mechanisms and outcomes. Let’s start with selling puts: 

Selling Puts: When you sell a put option, you agree to buy the underlying asset at a specific price, known as the strike price, before the option expires. The seller receives a premium for taking on this obligation. It’s common for investors to sell puts to generate income, or to acquire an asset at a discounted price.

Selling puts can look like an easy win, especially if the asset’s price hovers above the strike price. But here’s the kicker: if that price takes a nosedive below the strike, you might get stuck buying the asset for more than it’s now worth. That can be an expensive mistake… 

Let’s see what selling a put looks like graphically: 

Profit/loss chart for selling puts options strategy. A line chart showing potential gains above the strike price and potential losses below the strike price.

Above is a visual representation of the potential gains and losses associated with the ‘selling puts’ options strategy.

You can see in the graph above how if the underlying asset’s price increases, potential gains are limited, but below the strike price, potential losses can be substantial. Now let’s look at buying calls. 

Buying Calls: On the flip side, buying a call option at its premium, or price, gives you the right, but not the obligation, to buy the underlying asset at the strike price before the option expires. While this play grants you the right to purchase shares at a set price within a set time, it comes at a cost, aka the option’s premium. This strategy is often employed to speculate on an asset’s price increase, or to hedge against potential losses in other investments. 

To profit with long calls, you want the asset’s value to go beyond the strike price. If it does, the buyer can exercise the contract, meaning they choose to purchase the underlying stock at the strike price, and subsequently sell at the higher trading price, thus realizing a profit. But, if the price stays below the strike price, the most you’ll lose is the premium paid. This is a nice benefit that differs compared to selling puts. 

No let’s check out the profit/ loss graph for buying calls: 

Profit/loss chart for buying calls options strategy. A line chart showing potential gains above the strike price and limited losses equal to the premium paid.

Above is an illustrated depiction of the potential gains and losses linked with the ‘buying calls’ options strategy. This strategy offers the right, but not the obligation, to buy an asset at a predetermined price.

You can see that potential losses are limited only to the premium paid, while potential gains are theoretically unlimited as the asset’s price rises. 

In summary, with selling puts, you risk being assigned the contract (assignment), but you earn a premium upon selling; while buying calls grants you the option to purchase stock at a set price, and max loss is capped. Both have their benefits, but they come with different risk profiles, rewards, and ideal market scenarios. 

Comparing Selling Puts and Buying Calls

Short puts and long calls have very different characteristics – both in the ways they realize profits and losses, and the best times to use them. Both have their benefits and drawbacks. Let’s start by looking at profits and losses.

If you’re selling puts, unfortunately you’re exposed to potentially unlimited losses if the underlying price drops significantly. This contrasts with buying calls, where risk is limited only to the premium paid. As far as profit goes, with selling puts your profit is limited to the premium initially received from selling the contract, but you can profit from little to no movement in the underlying price. Buying calls can lead to potentially unlimited gains, but the underlying asset’s price has to rise to capture profit. 

So when’s the right time to use either strategy? 

Practical Applications and Examples

Let’s look at an example now that we understand the nuts and bolts of short puts and long calls. Let’s say an investor anticipates moderate growth or stability in an underlying asset’s price, so they decide to sell a put. This approach allows the investor to earn premium income or acquire the asset at a discounted rate if the price dips to the strike price. 

On the contrary, buying calls comes into play when a trader is highly bullish about an asset. For instance, let’s say an investor is anticipating Apple (AAPL) to release the iPhone 15 in September, around the same time they have in the past, so they decide to buy a call before the potential announcement rolls around. The investor purchases the right to buy AAPL at a predetermined price, potentially reaping significant gains if their prediction comes true, as they’d have the right to buy AAPL below its current market value. 

In essence, the choice between selling puts and buying calls is entirely circumstantial and depends on how much risk you want to take on, and where you feel the underlying price will go. Selling puts might be seen as a more conservative approach to generate income, or perhaps a cheaper way to get stock you want, while buying calls may serve as a tool for aggressive speculation on asset price growth.

Evaluating Risks and Crafting Mitigation Techniques

We’ve talked about the risks associated with selling puts and buying calls. Now let’s talk about how to hedge that risk. When you sell puts, you might end up having to buy the stock at the agreed price if things go south. If the stock’s price tanks below that price, you’re losing money. So how do you protect yourself? You set some cash aside to buy the stock if needed, or set a stop-loss order to cap the financial bleeding. 

Now let’s talk about buying calls. There’s allure here too, but it comes with its own trap. Imagine paying for a concert ticket only to have the show canceled. That’s sort of what happens if the stock doesn’t rise as you’d hoped. Your call option could expire worthless. To help prevent this, only go for call options when you feel certain the stock’s set for an uptick, or weave them into more intricate options trading strategies

For both strategies, you need to really get the market and the stock you’re dealing with. Keep an eye on things to make smart, timely choices. If you don’t have the time to keep an eye on things though, many traders set themselves up with options alerts services so they can stay on top of their trades while they’re away. 

Conclusion

Alright, so we’ve gone deep into the world of selling puts and buying calls. Each strategy has its own perks and pitfalls. Buying calls can be a safer play, having capped losses, and the potential for infinite profit. Selling puts could be riskier as you could lose significantly, but you can get a stock at a cheaper price or generate a steady income through premiums. 

Here’s the key takeaway: This is your game to play, but you’ve got to know the rules. Understand what you’re aiming for, what level of risk you can stomach, and keep an ear to the ground on market buzz.  It’s also essential to have a risk management plan in place. For selling puts, have enough capital set aside in case you need to buy the underlying asset. For buying calls, be clear on your exit strategy, especially as the option approaches its expiration date. 

So to wrap things up, whether you want to sell puts or buy calls, just be sure you’ve done your homework. Know how each works and the best scenarios for using them. With the right info and strategy, you can trade with more confidence and, hopefully, success.

Selling Puts vs Buying Calls: FAQs

What are the Fundamental Differences Between Selling Puts and Buying Calls?

Selling puts and buying calls are two distinct options strategies. Selling puts allows a trader to collect premiums with the obligation to buy the underlying asset if it reaches a certain price. It’s generally considered more conservative, targeting income generation or acquiring assets at a lower price. Buying calls, conversely, gives the right (but not the obligation) to buy the asset at a set price before the option expires. It’s a more aggressive approach, aiming for significant profits during bullish market trends.

In What Market Conditions Is Selling Puts Generally More Favorable?

Selling puts can be more favorable in neutral to slightly bullish market conditions. Traders sell puts to generate income or to buy the underlying asset at a discount. In a stable or moderately rising market, selling puts can offer consistent income with relatively lower risk.

What are the Primary Risks Associated with Buying Calls, and How Can They Be Managed?

Buying calls can be risky if the underlying asset’s price doesn’t rise above the strike price before expiration. The entire investment in the call option can be lost. To manage this risk, traders often set stop-loss orders, analyze underlying trends thoroughly, and consider the option’s expiration date carefully to ensure alignment with market outlook.

How Do I Decide Which Strategy to Implement in My Trading Portfolio?

Deciding between selling puts and buying calls depends on individual investment goals, risk tolerance, and market conditions. Selling puts may suit conservative investors aiming for steady income, while buying calls may appeal to those seeking larger profits from bullish trends. 

Can These Strategies Be Combined or Used Concurrently in an Investment Strategy?

Yes, selling puts and buying calls can be combined or used concurrently as part of a more complex trading strategy. Combining these strategies can create hedging opportunities and allow for more nuanced positioning in various market conditions.