InvestorQ : How should a trader decide whether to buy a put option or sell a call option?
Crowny Pinto made post

How should a trader decide whether to buy a put option or sell a call option?

Answer
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2 years ago


Your decision whether you should buy a put option or sell a call option will be broadly guided by the following 4 considerations:

Are you having an affirmative view on the stock or index going down? In that case it makes more sense for you to buy the put option. Your down side risk will be limited to the option premium paid and your profits in case the stock falls will be unlimited.

Are you having a cautiously non-affirmative view on the stock? In this case you are only confident that the stock price is unlikely to rise beyond a point. You are indifferent to whether the stock price goes down or stays stagnant at current levels. In such cases, it makes eminent sense to sell the call at the strike where you believe the stock to top out. You can also sell a lower call for higher premium but that is taking on unnecessary risk.

Can you pay the margins for the trade? When you buy a put option your total liability is limited to the option premium paid. That is your maximum loss. However, when you sell a call option, the potential loss can be unlimited. Hence your margining will be exactly like how the margins are imposed on futures. Be prepared for higher capital outlay in this case.

Lastly, are you playing for a rise in volatility or fall in volatility in the market? If you are playing for a rise in volatility, then buying a put option is the better choice. However, if you are betting on volatility coming down then selling the call option is a better choice. How to trade put and call options is all about knowing the difference between call and put options in terms of risk and return potential. Your choice can actually be a simple one!