In 2023, investors traded more than 10 billion equity options, according to The Options Clearing Corp., marking a whopping 128% increase from 2019’s volume of just over 4.4 billion. It’s hardly a stretch to say options came of age during the pandemic and continue to have their day among all types of investors.
Despite the popularity, options often confuse everyday investors. Once you know the basics, a good start to demystify things is to differentiate call versus put options.
An overview of puts and calls in options trading
Many professional traders and investors have had options trading in their arsenal for decades. But during the stay-at-home portion of the pandemic, interest in the stock market boomed. In January 2021, six million Americans downloaded brokerage apps on top of the 10 million who opened brokerage accounts in 2020. This coincides with the aforementioned exponential increase in options trading.
Even though many of these new market entrants didn’t know the difference between a call versus a put option, user-friendly brokerage platforms, such as Robinhood, made options appear easy to trade. The idea that you could profit from a rising stock using less money than if you bought the stock directly sounds incredible. However, even with an understanding of how options work, you can lose money.
Typically, you use call options when you think a stock will go up. You use put options when you think a stock will go down. While typical, this isn’t always the case. You can express negative sentiment on a stock via call options and positive sentiment with put options. Ultimately, there’s an option strategy for almost every situation.
Buying call options versus buying put options
When you buy a call option, you pay a premium for the right to purchase the option’s underlying stock at a set price on or before the option’s expiration date. When you buy a put, the same thing applies in the inverse. You can sell the underlying stock at a fixed price on or before expiration. Each type of option contract controls 100 shares of stock.
If you don’t know the terms included with these definitions, don’t worry. There’s a handy glossary at the end of this guide. For call and put option examples, see our guide on options basics.
On the put versus call option conundrum specifically, just know that you buy a call to profit from upside in a stock, and you buy a put to profit from downside.
Writing call options versus writing put options
Writing puts and calls means the same thing as selling them. You can use the terms — write and sell — interchangeably.
An option is a contract between two parties. We just defined the call and put buyer’s basic rights under this contract. When you write — or sell — a call, you’re obligated (it’s not a choice) to sell (often called “deliver”) the underlying stock to the call buyer at a set price on or before the option expiration date. When you write — or sell — a put, you’re obligated to buy the underlying stock from the put buyer at a set price on or before the option expiration date.
Generally, you write a call option when you think a stock will go down, and you write a put option when you think a stock will go up.
Consider a call option with a $50 strike price. If you think the underlying stock will go down, you can sell the call, collect the option premium and, if you guessed correctly, not have to deliver the stock. That’s because the buyer of a $50 call option will not want to exercise their right to purchase the underlying stock at a price that’s higher than the current market price. However, if you guessed incorrectly and the stock increased in value, you still keep the option premium but will have to deliver the stock to the call buyer at the option’s strike price.
The opposite is true for put options. If you think a stock will go up, you can sell the put, collect the option premium and, if you guessed correctly, not have to buy the stock. That’s because the buyer of a $50 put option will not want to exercise their right to sell the underlying stock at a price lower than they could receive on the open market. However, if you guessed wrong and the stock decreased in value, you keep the option premium (as with a call) but will have to buy the stock from the put buyer at the option’s strike price.
These call option versus put option differences will become clearer as we discuss option strategies and risks for beginners and define the key terms in our glossary.
Getting started with options trading strategies for beginners
While it’s nice to know the difference between a call and put, it’s better to know why and how to use them.
At the most basic level, call and put options give investors leverage. It costs $5,000 to purchase 100 shares of a $50 stock, but it only costs a small fraction of that to purchase a call option and control 100 shares of that same stock, which leads to one popular strategy.
While you can buy a call, hope the underlying stock moves past the strike price and then purchase it at the lower strike price, you can also opt never to buy the stock. You can trade the premium. All else equal, a call option’s premium should increase in value if the underlying stock moves higher. If it does, you can sell the call option — closing your trade — for more than you bought it for.
A similar, though inverse, strategy applies to puts. A put option’s premium should move higher if the underlying stock moves lower. In this case, you trade the put option premium just as you would a call.
Selling calls and puts can get considerably more confusing and beyond basic. For beginners, it’s usually best to stick with writing covered calls, which means writing calls against a stock you already own.
How is risk measured with options?
When it comes to risk, it runs the spectrum when you trade options.
In the most basic call and put buying strategies, your risk is limited to the premium you paid. If your option contract expires worthless — as in, it’s not worth it for you to exercise your right to buy or sell the underlying stock — you’re out that money.
There are myriad ways to measure risk with options. Quite a few go beyond the beginner level. However, if you understand time decay, you’re well on your way to understanding and measuring risk with options.
Simply put, the closer you get to option expiration, the more the value of an option premium will erode. This is because there’s less time for the desired stock movement to occur. For example, you might pay $4.00 per share for a call contract with a $50 strike price and an expiration date of July 2024 when the stock trades for $40 in January. However, a call on the same stock with a $50 strike price and expiration date of March 2024 will usually cost less because traders aren’t willing to pay as much of a premium for a shorter window of time to see the desired movement.
The option Greeks — one being Theta, which measures time decay — delve into more advanced territory and help not only define and assess risk but explain the way option prices react to factors such as movement and volatility in the underlying stock.
Glossary: Options trading terms and definitions
This guide focused on the basic differences between call and put options. We used several terms that might have been unfamiliar. Therefore, pulling from our guide on how to trade options, here are some of the key definitions for the option terms mentioned earlier.
- Underlying stock: An option derives value from the asset that underlies it. In this case, a stock. If you buy an Apple call option, you have bought the right to purchase 100 shares of Apple, which is the underlying stock.
- Premium: This is the price you pay for an option contract. When you buy a call or put, you pay a premium for the right to buy or sell the underlying stock. Numerous factors, such as time to expiration, dictate the value of an option premium.
- Expiration date: This is the date the option expires.
- Strike price: The strike price is the set price where you have the option to buy or sell the underlying stock.
Between this and our other options guides, you should grasp important options language and how to execute basic strategies, particularly using relatively straightforward approaches with calls and puts.
Frequently asked questions (FAQs)
Think of calls and puts as opposites. When you buy a call, you purchase the right to buy the underlying stock. When you buy a put, you purchase the right to sell it. When you sell calls and puts, the inverse holds true.
You should consider buying a put when you think its underlying stock will go down, as an alternative to the more risky strategy of short-selling a stock.
When you write a covered call, you run the risk of having to sell a stock you own at the call option’s strike price, even if its market value is higher than the strike price. This is known as assignment risk. When you write an uncovered call, also known as a “naked call,” your potential loss is unlimited. If the underlying stock soars past the strike price, you’ll need to purchase it at the market price, whatever that might be, then sell it to the call buyer at the strike price.
