Strategy Showdown: Buying Options Vs. Selling Options

The pros and cons of buying and selling options

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    There are two types of options in the stock market: put options and call options. There are also two ways to trade these options: selling them, or buying them. As a beginner, all these different ways to trade can be overwhelming, but once you understand the fundamentals of how options work, you can make more informed decisions in your portfolio.

    Buying Options

    Buying Call Options (Bullish)

    When people decide to get into options trading, most are drawn to the idea of buying call options. When you buy a call option, you are buying the right but to buy 100 shares of stock at a predetermined price called the strike price. It is cheaper to buy a call than it is to buy 100 shares of the stock. Due to this, it is very easy to leverage your account without paying margin interest. Leverage is always a double-edged sword though. Your reward potential will be higher, but your risk will also be higher.

    The main downside to buying a call is that you only have until the expiration date to get it right. In addition to this, the value of options decreases each day since the expiration date gets closer each day. When buying shares, on the other hand, you can hold them forever and they will not lose value, plus you do not have to be right within any specific timeframe.

    Buying Put Options (Bearish)

    Buying a put option is like buying a call except you are paying for the right to sell 100 shares of stock instead of buying 100 shares of stock. The best way to look at put options is to think of it as an insurance plan for your stocks. Just like car insurance, you pay a premium to be insured just in case something goes wrong. If your stock tanks hard, you will be compensated with the right to sell them at a higher price. It's similar to  crashing your car, because your insurance policy will pay for the damage that you incurred in exchange for your payment of monthly premiums.

    Selling Options

    Selling Call Options (Bearish)

    We have gone over that buying a call option gives the buyer the right to buy 100 shares at the strike price. When it comes to selling call options it is the exact opposite. You are being paid by the buyer in exchange for your promise to sell them 100 shares of stock at the strike price. Selling call options without owning the underlying shares or a long call option carries a theoretical “unlimited risk” aspect to it. In the same way, shorting shares of stock has unlimited risk potential because the stock can go up infinitely. Generally, people will only sell call options as a hedge against their shares or another long call option -- creating a vertical spread.

    Selling Put Options (Bullish)

    Selling put options can be seen as turning your portfolio into a stock insurance company. Market participants will pay you a premium in exchange for your promise to buy their 100 shares at the strike price. For example, one investor owns 100 shares of AAPL at $100 per share. They decide to protect their portfolio by buying a put with a strike price of $90, so if AAPL falls below they are still able to sell their shares to the insurance company, which would be the seller of the put option. The most common strategy traders use when selling put options is the cash-secured put strategy. As opposed to buying 100 shares at the current market price, investors can use options to be paid to buy shares at a lower price.

     




     
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