Before purchasing a call or put option, it is important to understand the basics of options, as they can expose an investor to potentially unlimited risk. Once a basic understanding is established, investors can start to formulate a strategy and discover the advantages of puts and calls. Neither is particularly better than the other; it simply depends on the investment objective and risk tolerance for the investor. Much of the risk ultimately resides in the fluctuation in market price of the underlying asset.
Options Contract Definition
Advantages of Call Options
A call option gives the buyer the right to purchase the underlying asset at the strike price at any time before the expiry date. Thus, the seller is obligated to deliver the underlying asset at the strike price, once assigned. This can be advantageous for either the buyer or the seller, or both simultaneously, depending on each investor's position. For example, if Investor A buys a $20 call and the asset price increases to $30, they profit a $10 share price difference, minus the premium they paid to purchase the call. Investor B, who sold a covered call to Investor A, pockets the premium and sold their shares with a cost of $15 for a profit too.
Advantages of Put Options
A put option gives the buyer the right to sell the underlying asset at the strike price. With this option the seller is obligated to purchase the shares from the holder. Again, depending on the investor's goals, this could be advantageous for each of them. Suppose Investor A buys a put at $20 against a stock they paid $20 per share for as a hedge. If the price falls below $20 and they exercise their option, they reduces their losses. Meanwhile, the seller, Investor B, can profit from this assignment of shares if they foresee the price returning higher.