Buying call options and selling put options are considered bullish. What’s the difference between these two strategies?
Zarina
As you rightly mentioned, buying call options, and selling put options are executed when the expectation is bullish. One key difference between the two strategies per se is that when you buy a call option, you are essentially buying the right to buy the underlying asset at a predetermined price if the option ends in-the-money (ITM) on expiry. On the other hand, if you sell put options, you will have an obligation to buy the underlying security if the options become ITM on expiry. Note that, in our market, futures and options (F&O) contracts on stocks that are ITM are compulsory delivery. Only F&O contracts on indices are cash settled.
Other factors to remember while choosing between buying calls and selling puts are your view on volatility and direction of the underlying and the margin obligations.
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When you are bullish on a stock and expect it to rally sharply in the near term, the obvious choice should be going long on call options. A rally can give you both directional benefit and the benefit of rising volatility. Both these can push the option price higher.
In case you are uncertain about a rally but expect the price to stay sideways, selling put options can be beneficial. Because a potential consolidation in the stock can lead to time decay in options. So, even if the stock does not rally, all you need is the stock stays above the strike price of the put option you sold.
Another scenario apt for selling put options is that the underlying has faced a sharp decline in price and is now approaching a support, which you expect to arrest the fall. In this case, since the price has been falling sharply, the volatility would have already gone up. So, when the stock touches the support and starts consolidating or witnessing a pull back on the upside, the volatility will implode. Volatility implosion — quick decline in volatility can pull the option price lower swiftly. Hence, by selling put options, you can gain from potential volatility implosion and the change in direction – either to sideways or a rally.
Remember that selling requires higher margin and theoretically, the loss can be unlimited. Hence, proper risk management measures are a must. In option buying, premium paid to buy is the maximum risk, whereas in selling, you will be receiver of the premium which will be the maximum profit.
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