#745 - Why Sell A Put Instead Of Buy A Call?

The "Daily Call" From Option Alpha

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to answer the question, “Why sell a put instead of buy a call?” And I think the answer to this question is actually relatively straightforward, though I’m going to be making a lot of generalities in this podcast. There’s a lot of differences and nuances in different option expiration timelines and strike prices that you would use for the selling of a put or the buying of a call, so again, I’m just talking in generalities here, but the reason that you would sell a put option instead of a call option, number one, is that the put option as an option selling position has an implied volatility premium edge already baked into the contract. It’s this idea that we continue to talk about here at Option Alpha which is that implied volatility at the time that you enter a contract is typically overstated long-term. And so, when you’re selling options, you immediately have a pricing advantage compared to an option buying strategy. Even if they are relatively the same payoff diagram, but one is buying options, one is selling options, you would have a little bit more of an edge to the option selling side.

When it comes to buying a call option, I think the biggest downside to buying a call option is that you have to get both the direction of the stock right and the magnitude of the move or the magnitude of the move in implied volatility right in order to profit and I think that’s really, really hard to do. When you setup a put option and you’re selling a put option especially one that’s close to at the money or out of the money, you have a high probability trade in your favor, you don’t have to get the direction totally right. In fact, you can be wrong in the direction and the stock can actually fall. As long it doesn’t fall below your strike price, then you still could make money on the trade. I think to me, it comes down to this idea that when we reduce our upside potential as we would do if we sold a put option, we immediately get a higher probability of success, more likely outcome of a profitable trade and this is hard for people to sometimes grasp because what they look for is they look for these trades that have low risk and high reward, but what they don’t factor in is the low probability of success that those trades have on an ongoing basis. Again, just talking in generalities here, but hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.