Need put and call options explained? Both of these components make up the basis of all options trading strategies. However, while buying puts and calls is a profitable strategy, there are some important aspects to know before trading them.
Call options mean that traders believe the underlying security price is increasing. They are bullish or going long. Put options mean that traders believe the stock price is going down. They are bearish or going short. Directional bias is one of the most important differences.
Puts and calls are used in options trading. When you believe a stock will go up, you buy a call. When you believe a stock will go down, you buy a put. Trading puts and calls are a great way to trade big money stocks.
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Table of Contents
Put and Call Options Introduction
When purchasing a call option and put option contracts, you are given the right but not the obligation to purchase the option contract at a set price. This is known as the strike price.
One options contract is the equivalent of 100 shares of the stock. So, for example, if you are looking at a stock and the technical indicators are bullish, and you want to buy a call option, you would go to the options chain and pick the price you want to purchase the option with the expiration you want. There are also options charts to look at the visual of what’s happening.
When learning to buy call options, you must first understand a call. A call takes the bullish bias of a trade. A put takes the bearish side of a trade.
In other words, if you’re bullish on a stock, you’d buy a call option. Bearish would be a put. Why not buy a stock instead of the option? After all, stocks don’t expire.
You could follow a trading service in and out of their trades. That, however, isn’t a good idea. Most unsuccessful trades occur from new traders following the gurus in and out of trades.
It’s important to be in charge of your trading destiny. You can set the trade parameters when buying call options because you believe the stock will increase in price.
Expiration Dates
Call option and put option contracts have expiration dates. Therefore, they are not like stocks because you can hold them forever.
They expire and lose money faster the closer they reach the expiration date (Theta decay or time decay). So you can pick an expiration date of a week or go out a year or even two in some cases.
The more time you give yourself to capture the stock moves up or down, the better. You want your option to get to the price you picked (strike) at the time of purchase.
There are three different ways to buy a call or put option. They are in the money (ITM) at the money (ATM) and out of the money (OTM). If you buy a call option that is in the money, the strike price is below the stock’s market price.
When you are buying an in-the-money put option, the strike price is above the market price. If you want to buy a call or a put option that is at the money, then the strike price is the same as the market price.
An out-of-the-money call has a higher strike price than the market price. Conversely, an out-of-the-money put option has a strike price lower than the market price in this put and call options explained blog.
Technical Analysis
Knowing technical analysis basics is key to knowing which option is best. In addition, being able to read the indicators will tell you which direction the stock is going and the best entry and exit.
Using the daily chart is the best way to find patterns. Patterns are also important in determining the direction of the stock. Therefore, understanding how to read stock charts is fundamental to your trading success.
Put and Call Options Example
This is an example of calls and puts on an options chain in ThinkorSwim. The strike prices are broken down in whole and half dollar amounts. It shows ITM, OTM, and OTM.
How to Buy Call Options
- Choose your broker
- Fund your account
- Choose expiration date
- Pick strike price
- Look for high-open interest
- Look for volume = liquidity
- Have entry and exit place
- Place your order
- Take profits and limit risk
Stock options trading is a great way to make money no matter what the market is doing. Whether the market is up, down, or trading sideways, there’s a strategy to make money.
What is options trading? An options contract gives you the right but not the obligation to buy (call) or sell (put) a stock at a specified price within a set time.
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In other words, you pay the premium to have the option to own the stock without the commitment. One contract controls 100 shares.
As a result, trading options are often cheaper than stock market trading. Options have the perception of being risky and hard. While they have more moving parts than stocks, they can be quite lucrative if learned properly. When you learn to buy calls, you’re looking at the basic bullish principle of options trading.
An option expires. Therefore, they’re known as wasting assets. Components such as time decay or theta can work against you, which is a new concept if you’re starting to learn stock training.
Choosing a Broker
Brokers are a large part of trading. They’re the bread and butter of trading. Without them, you wouldn’t have the ability to place trades yourself.
As a result, when you’re learning to buy calls, you want to ensure you have a broker you’re comfortable with. Brokers that have easy-to-understand options chains are a plus.
The options chain is where you’ll buy call options. You can customize your options chain to show exactly what you want.
You can add one, two, or all, whether it’s the Greeks, implied volatility, or volume. Here at the Bullish Bears, we’re big fans of ThinkorSwim by TD Ameritrade for options trading.
They have a great platform with simulated trading, an easy-to-use options chain, and fantastic charting. As a result, you’ll be well on learning how to buy calls.
Learning Call and Put Options
You must also know how to close the position when learning to buy call and put options. That might seem obvious. However, that’s not always the case.
Make sure you know how to close out your position on your trade. Many times, right-clicking brings up the option to close. As a result, you’re able to get out of the trade.
Remember that risk management is key. When buying calls, you don’t want to get too greedy. You never go broke taking your profits.
We’ve all been in that place where we have a profit and want to hold on to get more money. Make sure you know where support and resistance are at. What are the candlesticks and patterns telling you?
Many times, greed and fear are the enemies of profit. When you can keep those emotions under control, closing out your call position helps protect your profit.
However, not every trade will be a winning one. As a result, learn to cut your losses quickly. With options many times, letting them sit in hopes of recovering isn’t the best idea.
Practice Trading
It’s important to practice when learning how to buy call options. It is essential to success since options aren’t as cut and dry as stocks.
Make hundreds of practice trades before you start using real money. You may think that sounds excessive. However, you’ll be grateful once things like time decay set in.
You’ll realize how much the Greeks affect profit and loss and how to use them to your advantage. Call buying is bullish.
As a result, you want to make sure you can find patterns along with support and resistance. Practice helps to work out the kinks. That way, when you go live, you’re prepared.
If you need more help, take our options course.
What Are the Types of Options?
- The different types of options are made up of calls and put
- You can be an options buyer or an options seller
- Naked calls or naked puts: a riskiest strategy
- Credit spreads are the safest and most popular selling strategy
- Debit spreads are directionally biased and riskier than credit spreads but less risky than naked calls and put
Entries and Exits
Put and call options explained: Missing out on a good entry or exit can cost you money. So if you miss your entry on a call or put option contract and it’s running, don’t chase it.
That is a great way to make sure you lose money. In addition, I find the MACD indicator helpful when looking at an entry or exit.
The MACD is the moving average convergence divergence and the trend-following momentum indicator. If I want to buy a call option, I’ll wait until the MACD moves from bearish to bullish. When buying a put option, I wait until the MACD goes from bullish to bearish. I use the 5-minute chart with the MACD indicator as a guide to looking for an entry.
Then I use the 1-minute chart to get my duplicate entry. I try to get in as close to the 9 EMA as possible. So remember: Daily chart to identify the trend (hourly chart or 4-hr chart is also ok).
Use the 5-minute chart to find the patterns and setup, then use the 1-minute chart to get a very clean entry for your options trade.
Best Trading Tools
Buy a Call Option or Write a Put
Those less willing to take risks may find it more suitable to purchase calls. Alternatively, those more experienced in trading and with a higher risk tolerance may opt to sell puts.
I love buying call options for two reasons. First, my losses are capped at the premium I paid, and second, my gains are unlimited! On the other hand, writing put options is the complete opposite. In this case, my gains are limited to the premium I received from the put. Additionally, my maximum potential losses are significantly higher. They are equal to the strike price minus the premium received. This is concerning.
Sell a Put Losses
The maximum loss possible when selling or writing a put equals the strike price less the premium received.
MAXIMUM LOSS = STRIKE PRICE – PREMIUM RECEIVED
Here’s a simple example:
Let’s say Company ABC is trading for $50 a share. I sell ten three-month put contracts with a $40 strike price for a $5 premium. As you recall from our previous posts, one put contract equals 100 shares.
The math on the option premium you should collect is as follows:
$5 premium x 100 shares/put contract x 10 contracts = $5000
So far, so good.
However, just before the options expire, Company ABC gets into some hot water – a fraud scandal and has to file for bankruptcy. Fraud isn’t good for business, and their share prices tank to almost zero.
At this point, the put buyer (me) will exercise my option to “put” or sell the garbage shares at the $40 strike price of $40. Unfortunately, I’m forced to buy these worthless shares at $40 each, at a total cost of $40,000. If this cloud has a silver lining, I’m only out $35,000 as I had collected the $5,000 in options premium upfront.
Volatility
Volatility is one of the main determinants of an option’s price. The degree of variation in the underlying asset’s price is what volatility refers to in options trading. It measures the market’s expectation of the stock’s future price movements.
High volatility generally leads to higher option prices, while low volatility tends to lower options. There are a few reasons why volatility influences option pricing:
- Impact on the probability of reaching the strike price: Higher volatility increases the likelihood that the stock price will move significantly toward the strike price, making the option more valuable.
- Influence on time value: Volatility affects the time value component of an option’s price. As volatility increases, the stock’s potential for larger price swings increases. This higher potential for price movement adds to the option’s time value.
- Pricing of expected future volatility: Pricing models for options, such as the Black-Scholes model, consider the expected future volatility a significant factor. If the expected volatility is high, the option prices become expensive since it implies a higher chance of significant price fluctuations.
It is important to note that volatility is just one-factor determining option prices. Other factors include the stock price, time to expiration, interest rates, and dividends.
Final Thoughts: Put and Call Options
Put and call options explained means buying a call option, and put option contracts are a great way to make money in the stock market. First, however, you must study and practice to succeed.
If you don’t do this, you can end up taking losses. You will lose on some trades, but knowing when to close your trade is important and is where technical analysis comes in.
The technicals help with making trading decisions and remove a lot of the emotions. Regardless, stock trading can generally be stressful and sometimes take its toll.
Be cautious when writing in volatile markets, as option price depends heavily on volatility. If you take advantage of the increased volatility to get higher premiums, keep in mind that your put might become more expensive if the volatility trend continues to rise. This could result in a loss if you choose to close the position. If you think the rise in volatility is temporary and will go down in the future, writing puts could still be a good strategy.
Frequently Asked Questions
Buying a call option is best if you believe the underlying asset is increasing in price. Buying a put option is best if you believe the underlying asset is going down in price.
Call options are purchased when the buyer believes the underlying asset is price will rise. Put options are purchased when the buyer believes that the underlying asset is price will decrease.
Investors buy a put when they believe the price of the security is going to decrease. They sell a put when they believe that the price of a security will increase.
A call option buyer makes money if the underlying asset (e.g., a stock) rises above the strike price before expiry. A put option buyer makes money if the stock's price falls below the strike price before expiration.
- Here’s when you should buy a call option strategy:
- When you’re sure the price is strongly going to go up, You’re long the stock
- Don’t buy a call option if price looks bearish
- Avoid call options in a range-bound market
- Consider alternatives such as a put credit spread or call debit spread
