Understanding Buying Call vs. Selling Put

by Aron Vaxen
13 June 20244 min read
Understanding Buying Call vs. Selling PutUnderstanding Buying Call vs. Selling Put
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Buying Call Vs. Selling Put

Many people think stock options are very risky. However, adopting commonly used strategies can help you increase your profits and minimize losses while buying a call or selling a put.

Let us first understand these terms.

Buying Call

A buying call is when the buyer pre-determines the price of a security and is bullish (expects the price to increase) on it.

The buyer has the right to buy underlying shares at the agreed predicted stock price (strike price) at the end of tenure (expiry).

Since the buyer is not obligated to exercise the call, in the event of the price falling, the maximum loss possible will be to the extent of the premium amount only.

For example, you think the price of the shares of ABC Ltd will increase and reach Rs. 100 in one week. Right now, it is Rs. 75.

The call options for ABC Ltd are trading at a strike price of Rs. 85 at the end of one week (expiry). So, you pay the premium of Rs. 10 and buy the call.

If the price of the share has increased to Rs. 100, you will make a profit of Rs. 15. If the price is Rs. 85, you will incur a loss in the form of the premium paid. 

Few things to keep in mind while buying call options:

  1. Buy a call option if you anticipate an increase in the price.
  2. If the price goes down, you stand a chance of losing the premium.

Selling Put

Now, if you reverse roles from a buying call option, you will arrive at selling put options. If you anticipate the price of your stock options will increase, you can choose to sell them at a premium. S

omeone buying put options from you will be the one paying you the premium.

For example, you expect the stock of ABC Ltd to increase to Rs. 90, so you sell put of Rs. 85 strikes. This is at an Rs. 10 premium above the current price of Rs. 75.

If the price moves to Rs. 90, you will only get Rs. 10, which is the premium.

Few things to keep in mind in selling put:

  1. In selling put, the profits are limited to the premium received.
  2. There is considerable risk when the stock price moves in the opposite direction of your prediction.

How traders can identify market conditions

Using various technical analysis tools can help traders gauge the market movement and make financially sound investments accordingly.

Buying call options or selling put options in a bullish market could yield profitable returns. Here are some ways in which you can assess the direction of the market.

Put-Call Ratio (PCR)

Divide the number of traded put options with the number of traded call options. Typically, a higher PCR indicates a bearish market, while a low PCR indicates a bullish market.

Candlestick Charts

The decision to buy a call option or sell a put option depends on how bullish the trader is on the underlying stocks and how attractive the premium is.

A lot of research and technical analysis goes into deciding the right type of trading strategy.

Candlestick charts and candlestick patterns help in analyzing market conditions and help traders forecast future price trends.

Candlestick charts are quite effective for visualizing and predicting price movements. There are two basic types of candlesticks. These are:

  1. Bullish candlestick: when the close is higher than the opening price
  2. Bearish candlestick: when the close is lower than the opening price

Relative Strength Index (RSI)

So, to understand how strong a trend is, the RSI between 0 to 100 can be assessed by mapping the recent price increase to the recent price falls.

Based on the RSI, you can assess if a stock is oversold or overbought and foresee the probability of future movement.

RSI also indicates support and resistance levels for you to understand how low or high a stock price is likely to move and make your options trading decisions accordingly.

While buying call or selling put, a detailed study of the price, volume, and psychological indicators like market sentiment is a must. They are the key factors that may decide the future price of the stocks.

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