The Similarities Between Puts and Calls
More Alike Than Different
Obviously, puts and calls are very different types of options. Owning calls is a bullish play and owning puts is a bearish play. Other that that stark difference, puts and calls share many similarities and have lots in common. In fact, the educated option trader understands why the following statement is true: Calls are puts; puts are calls.
- To convert a call option into a position that is equivalent to a put option (i.e., a synthetic put), the call owner sells 100 shares of stock.
- To convert a put option into a position that is equivalent to owning a call option (i.e., a synthetic call), the put owner buys 100 shares of stock.
The Greeks are tools that measure specific risks of owning, or selling, options. One aspect of the Greeks that may not be obvious to the newer option trader is that the Greeks of paired puts and calls -- i.e., options with the same underlying asset, strike price and expiration -- share specific characteristics. For example:
- Delta. The sum of the call and put deltas for paired options is 100, when the + and - signs are ignored. More advanced traders understand that there are occasions when the sum of the put and call deltas is slightly greater than 100, but that is due to special circumstances in which it may be advantageous to exercise put options prior to expiration. In today's world of low-interest rates, this is a rare situation.
- Theta, Gamma, Vega. Consider a set of paired of options: Option buyers own a position with negative Theta (i.e., the option loses value as time passes), positive Gamma (option gains value when the market moves in the correct direction), and positive Vega (option gains value when implied volatility increases). Option sellers own a position with positive Theta, negative Gamma, and negative Theta.
The absolute value of each of these three Greeks is the same both the call and put when the options are paired.
- Buying. When a trader is confident that the underlying asset will move higher (or lower), then one viable strategy is the purchase of call (put) options. Whether it is wise to adopt that strategy is a controversial topic. My recommendation is that this strategy is best avoided unless you prefer to own a deep-in-the-money call option as a reduced risk substitute for owning stock.
- Selling. Selling (writing) options is a popular methodology among individual investors and professional traders. The concept is simple: The trader profits when time passes and the options that were sold steadily lose value. Of course, this strategy is much more complicated than that because traders who sell options (naked, or as part of a spread), must be careful to manage risk. In other words, large losses must be prevented when the trader plans to survive and prosper over the longer term.
- Hedging (Reducing risk). When you already own a stock or option position, one idea that helps traders succeed is to hedge (reduce the risk of owning) positions. There are numerous hedging strategies, but one of the most popular is for stock owners to buy options.
Another example is the purchase of any call or put option such that it makes the original position less risky to own. For example, when selling a naked put option, I recommend buying another put -- one that is farther out of the money, but with the same expiration date. This limits losses when the unexpected (big decline in the stock price) occurs.
- Speculation. It is quite tempting for rookies traders to use options as a gambling tool. The preferred speculative strategy is buying options that are far out of the money -- just because they are inexpensive -- and then hoping that the stock price performs some magic. Needless to say, this play is unlikely to win. However, the payoff can be very large (>1,000% return), and for some traders, that is just too attractive. This strategy should be reserved for times when the options are fairly price and you expect a substantial stock price change.
Please do not make the mistake of trading call options when your intention is to trade puts. But do be aware that these options have a bunch of similar characteristics and one can readily be converted into the other.