When does one sell a put option, and when does one sell a call option?

By Casey Murphy AAA
A:

The incorporation of options into all types of investment strategies has quickly grown in popularity among individual investors. For beginner traders, one of the main questions that arises is why traders would wish to sell options rather than to buy them. The selling of options confuses many investors because the obligations, risks and payoffs involved are different from those of the standard long option.

To understand why an investor would choose to sell an option, you must first understand what type of option it is that he or she is selling, and what kind of payoff he or she is expecting to make when the price of the underlying moves in the desired direction.

Selling a put option - An investor would choose to sell a put option if her outlook on the underlying security was that it was going to rise. The purchaser of a put option pays a premium to the writer (seller) for the right to sell the shares at an agreed upon price in the event that the price heads lower. Since the premium would be kept by the seller if the price closed above the agreed upon strike price, it is easy to see why an investor would choose to use this type of strategy. (To learn more, see Introduction To Put Writing.)

Selling a call option without owning the underlying asset - An investor would choose to sell a call option if his outlook on a specific asset was that it was going to fall. The purchaser of a call option pays a premium to the writer for the right to buy the underlying at an agreed upon price in the event that the price of the asset is above the strike price. In this case, the option seller would get to keep the premium if the price closed below the strike price. (For more on this strategy, see Naked Call Writing.)

Another reason why investors may sell options is to incorporate them into other types of option strategies. For example, if an investor wishes to sell out of his or her position in a stock when the price rises above a certain level, he or she can incorporate what is known as a covered call strategy. (To learn more, see Come One, Come All - Covered Calls.) Many advanced options strategies - iron condor, bull call spread, bull put spread, iron butterfly - will likely require an investor to sell options.

To learn more about options, see our Options Basics Tutorial.

RELATED FAQS

  1. What are the best indicators for evaluating technology stocks?

    Technology stocks are often some of the most discussed stocks on the news. How can investors spot the company that will roll ...
  2. What technical indicators can I use to find undervalued stock?

    Investors seeking new ideas may want to look to technical analysis to see whether the market has undervalued a particular ...
  3. What's the difference between binary options and day trading?

    Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. ...
  4. If a LEAP option is purchased and held for more than 12 months, is the tax treatment ...

    A LEAP (long-term equity anticipation security) is a call or put option that allows the buyer a long-term expiration on the ...
RELATED TERMS
  1. Forex Spread Betting

    A category of spread betting that involves taking a bet on the ...
  2. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  3. Short Put

    A type of strategy regarding a put option, which is a contract ...
  4. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  5. Mass Index

    A form of technical analysis that looks at the range between ...
  6. On-Balance Volume (OBV)

    A momentum indicator that uses volume flow to predict changes ...
comments powered by Disqus
Related Articles
  1. Playing Penny Stock-Like ETFs
    Stock Analysis

    Playing Penny Stock-Like ETFs

  2. How To Buy Oil Options
    Options & Futures

    How To Buy Oil Options

  3. Hypothesis Testing in Finance: Concept ...
    Active Trading Fundamentals

    Hypothesis Testing in Finance: Concept ...

  4. Using the Coppock Curve to Generate ...
    Technical Indicators

    Using the Coppock Curve to Generate ...

  5. Technical Top-Down Investing: Analyzing ...
    Retirement

    Technical Top-Down Investing: Analyzing ...

Trading Center