What is the difference between buying a call and selling a put?

By Research Desk
about 3 years ago

While both buying a call and selling a put denote that one is bullish on the stock, they are different with respect to the following:

Right and obligation – When one buys a call, one has the right but not the obligation to buy the underlying at the strike price on expiry of the option. In this case the buyer has the control and is in the driving seat.

In case of selling a put, the seller does not hold any right, but will be obliged to buy the underlying at the strike price, if the buyer of the put were to exercise his right upon expiry.

Premium and margin – Buying a call requires the buyer to pay premium to the seller of the call. However, no margin money is required to be paid to the stock exchange for the same. On the other hand, selling a put requires the seller to deposit margin money with the stock exchange, in lieu of which he gets to pocket the premium on the put.

Return (Profit or Loss) – In case of buying a call, the loss /downside is limited to the extent of premium paid while profit / upside can be unlimited, depending on the price movement of the underlying.

e.g. If Company A 460 CE of lot size 1000 is bought at premium of Rs. 4 per share, maximum loss is the premium paid of Rs. 4,000 (Rs. 4 per share X 1,000 shares per lot). Profit is unlimited since theoretically share price can move to any level on the upside. If the share price falls below 460, the buyer will not exercise the call and his loss will be limited to Rs. 4,000.

The exact opposite is true for selling a put. While the profit / upside is limited to the extent of premium earned, loss / downside is (practically) unlimited.

e.g. If Company A 460 PE of lot size 1000 is sold at premium of Rs. 4 per share, maximum gain is the premium earned of Rs. 4,000 (Rs. 4 per share X 1,000 shares per lot). Profit is limited to Rs. 4,000 while the loss is unlimited since theoretically share price can move to any level on the downside. If the share price falls below 460, the put will get exercised, leading to loss for the seller of put option. If share price rises, the put will not get exercised.

Which to choose? - Buying a call gives an immediate loss with a potential for future gain, with risk being is limited to the option's premium. On the other hand, selling a put gives an immediate profit / inflow with potential for future loss with no cap on the risk. Thus, if one holds a bullish view, one must choose between buying a call and selling a put based on his risk bearing ability.

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