If you are optimistic should you buy a call or sell a put

Buy a Call or Sell a PutYou might ask yourself should I buy a call or sell a put?  I have the idea that most new option trades have the assumption that buying a call strategy would outperform the underlying stock. They also might think that short put position would be a losing strategy. But a recent report challenges these notions.

Buying calls is defined risk position with potentially unlimited profits, at least in theory. You can earn unlimited profits when the underlyings moves up. Your loss is limited to the option premium you have paid for.

On the other hand, selling puts is considered highly risky. The stock might go to zero or you may be forced to buy stock at well above the actual market price on a big decline. You may keep the option premium if the the underlying does not move up, stays flat or moves a little bit down!

 

What is better buy a call or sell a put?

What is more profitable in a bullish market, selling a put or buying a call? A recent study of tastytrade gave us more insight. Let us look at the  graphs below. The left graph represent the profit or loss for a call option. And on the right you find it for the put. When the underlying moves to the red zone you experience a loss and the green zone you have a profit.

 

The call buying strategies significantly underperform owning the market. It is clear that the shorter the term of the options, the more the time decay affects the positions. That is why the one-month calls do the worst.

Conversely, the put-selling strategy significantly outperforms the market. And it does so with a huge reduction in volatility –roughly 30 percent–with a much smaller maximum draw-down.

The basic idea behind put selling is that you get paid an option premium to take on the downside risk of the market. It has limited upside and increasing exposure to the downside with essentially all the risk of the market (minus the premium).

A short 30 Delta put has a win rate of 93% in the bull market of the last 9 years.

From the picture you see that a call needs a 2.5% move in the underlying to make a profit. If you have sold a put you make a profit when the underlying moves the desired direction, stays flat or even goes against a little bit (4.5%) goes against you.

 

Conclusion

To act on a bullish assuption with options, you can buy calls. You can buy calls as opposed to selling puts to limit risk. But it has a lower probability of success. You only have a profit if the stocks moves above the breakeven before expiration.

Short puts are a bullish strategy also. It requires no extra movement to profit and have a much higher average porfit or loss than the long call alternative.

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