Last updated on May 4th, 2022 , 08:58 am
Both the long call and short put options strategies are bullish. This is the limit of these option positions similarities. In terms of risk/reward, these two strategies couldn’t be any different. Before we get started, it is important to understand that the long call is not synonymous with the short put options strategy.
Let’s look at a couple definitions, then get to work!
Long Call Definition: A relatively low-risk bullish options strategy that involves the purchase of a stand-alone call option contract. For American Options, the call owner has the right to exercise their option and purchase 100 shares of long stock at the strike price at any time.
Short Put Definition: A high-risk bullish to neutral options strategy that involves the sale of a put option. For American style options, the seller must stand ready to deliver 100 shares of stock when/if the long party decides to exercise their contract. Short selling options involves great risks.
TAKEAWAYS
- The long call is a low-probability derivative trade with limited risk.
- The short put is a high-probability derivative trade with limited (but great) risk.
- Long calls profit when the underlying stock, ETF or index moves up significantly.
- Short puts profit in both neutral and bullish markets.
- The maximum loss for long calls is the debit paid; the maximum loss for short puts is strike price – premium.
- The maximum profit in long call options is unlimited; the maximum profit in the short put is the credit received.
| Long Call | Short Put | |
|---|---|---|
|
Market Direction |
Bullish |
Neutral and Bullish |
|
When To Trade |
Best for traders very bullish on a security |
Best for traders who believe a security will either stay the same or increase in value. |
|
Maximum Profit |
Unlimited |
Credit received |
|
Maximum Loss |
Entire debit paid |
Strike price minus the premium received |
|
Breakeven |
Strike Price + Debit Paid. |
Strike price minus the premium received for the put. |
|
Time Decay Effect |
As time passes, and both implied volatility and stock price stay the same, a long call will persistently shed value. |
As time passes, and both the implied volatility and stock price stay the same, a short put will shed value – which is desirable for short puts. |
|
Probability of Success |
Low |
High |
Long Call vs Short Put: Key Differences
Before we dig into these two options strategies themselves, let’s take a look at some of the major differences between the long call and the short put:
1.) Long Calls vs Short Puts: Trade Cost
When buying call options, you must may a debit. This debit represents the total loss potential. You can never lose more than you pay.
Selling a put option is a net-credit transaction. There is no debit paid. Instead, your broker will require you to set funds on the side in margin should that trade go against you and you have to buy the naked put back. When selling options, the margin can be substantial. Opportunity costs must be taken into account.
2.) Long Calls vs Short Puts: Maximum Profit
When you buy a long call, the upside is unlimited. Why? The stock can (in theory) go to infinity.
When you sell a put option (or any option), the maximum profit is always the credit received. You will never make more than the credit you take in initially.
3.) Long Calls vs Short Puts: Maximum Loss
For long call options, the maximum loss is always the initial debit paid. It doesn’t matter how much the stock moves against you, with long options, you can only ever lose the amount paid to purchase the option.
For short put options, the maximum loss is calculated Strike Price – Premium Received. If you sell an option at the 100 strike price for $1, you can, in theory, lose $99. This assumes the worst case scenario, with the price of the underlying security falling to $0 in value.
Note! Selling naked call options comes with unlimited risk. Learn more about short naked call options here.
4.) Long Calls vs Short Puts: Breakeven
➥ The long call breakeven is Strike Price + Debit Paid.
➥ The short put breakeven is Strike Price – Premium Received.
5.) Long Calls vs Short Puts: When to Trade?
Long Call Option Explained
The long call is reserved for the most bullish of investors.
Not only does this strategy require the stock to move up to make money, but it must move up by a lot.
Because of the Greek theta, options perpetually shed value. In a stagnating market, this is bad news for long calls. Let’s jump right into a hypothetical example to understand how this Greek works against long options.
Long Call: Losing Trade Example
Here is our long position: a call on Meta Platforms (FB):
Position
➥ Option: Long FB 200 Call
➥ Option Premium: $5.40
➥ Stock Price: 190
So let’s say we are long the above call. Two days have passed, and the stock price is unchanged. What does this mean for our position?
Position
➥ Option: Long FB 200 Call
➥ Option Premium: $5.40 —> 4.50
➥ Days to Expiration (DTE): 8 —> 6
➥ Stock Price: 190 —> 190
So, as we can see, with the passage of two days (assuming both implied volatility and stock price remain the same) our option loses value.
Time is the enemy of all long call and put options! As time passes and the stock remains the same, the odds of it reaching our strike price dims. Therefore, the option falls in value.
But long calls also have great upside potential. Let’s take a look at a winning trade next.
Long Call: Wining Trade Example
Position
➥ Option: Long AAPL 165 Call
➥ Option Premium: $1.30
➥ Stock Price: 160
So we have purchased a call option on AAPL for a cost of $1.30 (which actually costs us $130 remembering the multiplier effect of option leverage).
Two days have passed, and the price of AAPL has skyrocket:
Position
➥ Option: Long AAPL 165 Call
➥ Option Premium: $1.30 —> $4
➥ Days to Expiration (DTE): 8 —> 6
➥ Stock Price: 160 —> 165
In this example, our option price has increased in value by more than 100%. When you buy an option, the most you can ever lose is the premium paid.
The upside for long calls is unlimited. Why? There is no cap on how high the stock can go.
From a sheer risk/reward standpoint, long calls make sense. However, their probability of success pales in comparison to the short put option.
Short Put Option Explained
Unlike the long call option, the short put option can profit in almost any market. Short puts always profit in neutral and bullish markets, and can sometimes even profit in minorly bearish markets!
When compared to stock positions, long options are decaying assets. Time is kryptonite for long options.
So if the effect of time decay is negative for long options, shouldn’t it be positive for short options? Yes!
Most professional traders sell options for this reason. Although these high-probability trades come not without risks!
Short Put: Losing Trade Example
Let’s jump right into an example with a short put ETF option on SPY (an S&P 500 index tracker).
Position
➥ Option: Short SPY 415 Put
➥ Option Premium: $2.75
➥ Days to Expiration (DTE): 4
➥ Stock Price: $423
So we have sold a put option here at the market price of 2.75. As long as SPY closes above our short strike price of $415, we will collect our full premium of $2.75 ($275).
The stock can even fall to $415 and we will still make our full profit potential!
Let’s skip ahead a 2 days and see how our short put option did:
Position
➥ Option: Short SPY 415 Put
➥ Option Premium: $2.75 —> $8
➥ Days to Expiration (DTE): 4—> 2
➥ Stock Price: $423 —> $414
So that trade didn’t work out too well! Although the short put strategy has a high probability of success, when naked options move against you, watch out!
The most we could have ever made on this trade was the credit received of $2.75. With two days to the expiration date (expiry), SPY tanked, and our short put option is currently trading at $8. We have lost $5.25 in a scenario where our max profit was $2.75. Not the best risk/reward profile!
Short Put: Winning Trade Example
For this trade, we are going to sell a put option on Tesla (TSLA)
Position
➥ Option: Short TSLA 710 Put
➥ Option Premium: $26
➥ Days to Expiration (DTE): 14
➥ Stock Price: $764
So since we are selling an option, the most we can ever make is the credit received, In this scenario, that will occur when the stock is trading at or above $710 on expiration (our short strike price).
Let’s fast-forward to expiration day now:
➥ Option: Short TSLA 710 Put
➥ Option Premium: $26 —> $0
➥ Days to Expiration (DTE): 14 —>0
➥ Stock Price: $764 —>$750
So in this example, the stock fell from $764 to $750. Since we are short a put option, you may think that is bad. But we are short the 710 put strike! The stock is trading way above this level. On expiration day, our option is safely out-of-the-money and we will collect the full premium.
This example just goes to show that short put options can profit in all market directions.
Short Puts Margin Requirement
- 20% of the underlying price minus the out of money amount plus the option premium
- 10% of the strike price plus the option
premium - $2.50
Trading options come with great risks. To learn more about these risks, please read this article from the OCC.
Long Call vs Short Put FAQs
A short call is very different from a long put. Both strategies profit in bearish markets, but the short call has considerably more risk than the long put.
When you sell a put option, your broker will require funds be held in “margin” should that trade move against you. With short puts, the risk is significant.
Shorting a put option is simple – instead of clicking on the ask price in the option chain, simply click on the bid price and send the order. It is best to avoid market orders in options; limit orders are the better alternative.
A short call is a high probability trade with unlimited risk; a long put is a low probability trade with limited risk.
Is selling put options a good strategy for income generation? What’s the success rate for this trade?
Thanks!
Thanks for the question Amar. In neutral and bullish markets, selling put options naked can be a very lucrative strategy. However, all it takes is one bad month to wipe out years of put income collection.
Chris actually did a study on this topic. Check it out below.
https://www.projectfinance.com/short-put-management/