In addition to calls vs puts, you have another decision to make when trading options though: Whether to be a buyer or to be a seller of an option contract. In my first article about options, we only talked about options from the perspective of a buyer. This is how most people get into options trading in the beginning. However, being on the sell-side is actually very common among retail traders as well. Some experts even suggest doing more selling than buying options.
With two types of options and two sides of the market, options trading essentially gives you four overall approaches to the market: a) Buying calls, b) Buying puts, c) Selling calls, and d) Selling puts.
Calls and Puts
An option that gives you the right to buy the underlying asset is called a ‘call option’. One that gives you the right to sell the asset is called a ‘put option’.
In simplified terms, you want to buy a call option if you believe the asset will go up in the near future, and a put option if you think it will go down.
Buying a call is similar to outright investing in a stock or another asset in the sense that you’re profiting if the price of the asset goes up. For this reason, call options are also the easiest to understand for new traders. Put options require a little more attention.
Buying a put is tied to the practice of shorting a stock, which essentially means betting that the price of the stock will go down. When you short a stock, you’re technically buying the stock at its current price and then lending it out, hoping that you can buy it back at a lower price in the future.
In a regular short position, you need to decide for yourself when to pull the trigger and close your position, and your loss is hypothetically limitless because a stock can go up indefinitely.
When you’re buying a put option, your parameters are pre-defined: You know your timeframe, you know the price the stock needs to reach for you to make money, and you know your maximum potential loss — the premium you’ve paid — in case the trade doesn’t work out as planned.
Put options may be a little harder to grasp at first, but when you do, you’ll realize a whole new world of opportunities in the financial markets. You’ll be able to make money in the markets whether they go up or down or even sideways, and you’ll have the tools to deploy some powerful strategies by combining multiple options and types of options in one trade.
Buyers and sellers of options
Buying an option is the most accessible for beginners in the options market. However, whenever you buy an option, there’s obviously a seller on the other side of the trade — and you could potentially be that seller.
To understand the seller’s position, you can basically take everything we’ve discussed so far and flip it on its head. Everything you’re aiming for as a buyer of an option, the seller of that option is aiming for the opposite.
However, now you know about the exciting opportunities that come with buying options, you may be wondering why anyone would want to be on the opposite side as a seller of options.
Let’s say you think Apple is going to $165 in the next month. In simplified terms, you could approach this trade in two ways: 1) buy a call option, or 2) Sell a put option. Remember that the buyer of a put option is betting that the price of the underlying will go down, so by taking the opposite side of that trade you’re betting that the price will go up.
As the seller, you’ll collect the premium paid by the buyer, so you’ll “get paid” upfront for the trade. What’s more, time is on your side as the seller: The buyer needs Apple to move! The more it moves and the sooner it does so, the better!
You as the seller, on the other hand, will just sit back and profit from a slow market, perhaps some boring sideways action. The premium of an option will decay over time, something that’s to the advantage of the seller and a constant challenge for the buyer. We’ll get more into time decay in an upcoming article.
One key aspect to be aware of when deciding whether to be a buyer or a seller is the difference between rights and obligations. As an option buyer, you have the right to buy or sell the underlying asset. As the seller, on the other hand, you have an obligation to do so.
You’re essentially required to make the trade happen if the buyer wants it. It’s your obligation to take the other side of the trade if the buyer exercises their option. The premium is your payment for taking on this obligation.
Whenever the buyer doesn’t exercise their option, however, you’re pocketing the premium and walking away from the trade as the winner.
Further studies
I hope the above gave you a fundamental understanding of the different sides of an options trade and how you can approach a trading setup from different angles. You can either buy a call or sell a put to profit from an upward move in an asset, or you can buy a put or sell a call to make money on a move in the other direction. Exactly what’s right for you will vary from trade to trade and depend on your risk profile and strategy.
Although I’ll be covering the basics of options trading in a short series of articles, I encourage you to really dig in and educate yourself as much as possible. Below I’ve listed some of the resources I’ve personally found to be the most helpful. Let me know what you think if you decide to check them out, or if I missed some that should be on the list 👇
Option Alpha University
Easily the most beautiful website with the best overview and easiest navigation. I love their short written explanations accompanied by videos.
projectoption
This site really helped me with some specific topics that I had a hard time wrapping my head around. The comprehensive articles are supported by awesome visuals that really help with the understanding of more complex concepts.
tastytrade
One of the most popular go-to places for all-things-trading. They have a huge catalog of educational content in various formats, best practices, glossaries, and more.
