Differences Between Call And Put Options: How To Trade Both

Differences Between Call And Put Options: How To Trade Both

Before you trade a stock, you have to decide if you have to create a thesis that explains if you believe that the stock’s price will go up or down. While there are many ways to create a thesis (including many tools courtesy of Unusual Whales), if you do decide to trade the security you only have two choices: buying the stock if you think it will go up (taking a long position) or shorting the stock if you think it will go down (taking a short position). When playing options, you are faced with a similar decision as to when you decide what direction you think the stock will go, you will either buy call or put options, respectively. However, before we can differentiate and break down the differences between call options and put options, we need to know what a stock option is.

What Is A Stock Option?

A stock option is a financial derivative that gives buyers the right to buy or sell a stock at a specified price (strike price) at a preset date (expiration date) that is agreed upon before the transaction takes place. Being a derivative, stock options get their value based on the underlying stock’s current price and its movements. The value or price of an option is called the premium and the premium moves up or down based on a variety of factors, including the underlying stock’s price, time until expiration, and implied volatility (IV). Options are sold as contracts and each contract covers 100 shares of company stock.

The strike price is the set price agreed upon in the contract that specifies what price the option can be exercised at. If the underlying stock’s price is lower than the strike price comes the expiration date, then the option will typically expire worthless (you can technically exercise options out of the money, but it makes no sense).

The expiration date is the last day the contract can be bought or sold before it is exercised or expires worthless.

You can click here for another Unusual Whales article if you are interested in learning more about the differences between stocks and options and how to trade each one.

What Is A Call Option?

A call option is a stock option that gives the buyer the right, but not the obligation, to buy a stock at the expiration date at the strike price, given the underlying stock’s price is higher than the strike price. If the stock’s price is lower than the strike price at the expiration date, then the option expires worthless.

What Is A Put Option?

A put option is a stock option that gives the buyer the right, but not the obligation, to sell a stock at the expiration date at the strike price, given the underlying stock’s price is lower than the strike price. If the stock’s price is higher than the strike price at the expiration date, then the option expires worthless.

How To Trade Call Options

While buying an option contract with the intention of holding through the expiration date is a profitable strategy when done right, many traders will instead trade options, buying a contract at the current premium price and selling the contract at a later point in time at (hopefully) a higher premium price, or rather for a profit.

A common example of this is from traders trading large-cap options. A large-cap stock is a company whose market capitalization exceeds $10 billion. Some of the most popular large caps in terms of the trading volume include Apple ($AAPL), Tesla ($TSLA), and Lucid Motors ($LCID). Traders will play options of these stocks due to the fact the cost of one option contract will often be cheaper than buying the actual stock itself. Furthermore, these options can produce greater returns, although it comes with significantly more risk.

For example, let’s say that a trader believes that the price of Nvidia’s stock ($NVDA) will go up in the near future based on a technical analysis of the chart. The price of Nvidia is relatively high, so a trader who cannot buy fractional shares may decide to buy a call option on Nvidia. They buy one contract at a premium of $1, so the contract costs them $100. Well, just as their technical analysis predicted, the stock price of Nvidia increased so that the contract that once had a premium of $1 is now $2 and the trader decides to sell. This trader was able to make a profit of $100 on this call option.

Conversely, if the price of Nvidia decreased, his call option’s premium may only be $0.5 now. No matter what type of trading you do, protecting capital is imperative.

On unusual options alerts, Unusual Whales will use the letter “C” to symbolize that it is a call option.

An Unusual Whales' Call Option Alert For Apple

How To Trade Put Options

As the alternative to calls, put options are for those who believe that the stock’s price will fall. However, unlike calls which are primarily bought as naked options (no position in the stock prior to the purchase of the contract), puts are bought as both naked and covered options (a stock option that is bought as a hedge against a current stock position). You can read more about the difference between naked and covered options here.

As an example for a naked put option, a trader believes that the price of Disney ($DIS) is going to decrease in the future, the trader may buy a put option with the hopes of selling it with a higher premium at a later date.

A covered put option example is a long-term investor who expects the market to fall, thus the investor buys puts on his current stock positions as a hedge, or insurance. If the market does indeed fall, the investor makes money off the put option while if the market remains strong, all the investor lost was the money they paid for the contract.

An Unusual Whales' Put Option Alert For AMC

On unusual options alerts, Unusual Whales will use the letter “P” to symbolize that it is a put option.

Trading Options With Unusual Whales

Ever since the epic GameStop ($GME) short squeeze of January 2021, retail traders have begun to seize the market from the market makers, the ones with the insider information, including hedge funds, banks, and US Congresspeople, including Speaker of the House Nancy Pelosi and her infamous portfolio.

With Unusual Whales, retail traders are given access to a wide variety of tools that were previously reserved for only the big whales. For more about Unusual Whales, click here.