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This is a level 2 question.
Why would an investor sell a put instead of buying a call and vice versa?
Buying a call is a bullish strategy, while selling a put is a bullish-to-neutral strategy. A call buyer wins only if the stock rallies, while a put player keeps his premium even if the stock declines slightly, just as long as it remains above the option's strike price at expiration.
The main advantage of put selling (or writing) compared to call buying is that you can collect a premium by writing a put, which is something you cannot do when you purchase a call. We prefer put-selling strategies that involve writing an out-of-the-money put on a stock that an investor would be willing to buy if the shares took a temporary plunge. If the price of the stock should drop below the strike price of the put and remain there at expiration, the investor would be assigned, and would thus acquire the stock at a reduced price. Most of the time, though, the sold put will expire worthless, allowing the investor to pocket the premium and receive a 10- to 15-percent profit without ever having to buy the equity.
Put selling takes advantage of time decay, which is the loss of value of an option over time. Time decay allows an options trader to profit without having to correctly predict the future direction of a security's movement as long as it remains above the strike price. Time premium will decay at a fairly predictable rate and will decay most rapidly the closer the option gets to its expiration, aiding the put-sell position. It is also important to note that the value of an option will decline if the stock fails to move. This factor benefits the put seller, while its hurts the call buyer.
As for call buying, this basic strategy allows investors to benefit from an upward price movement in a particular security. This is not a benefit available to put sellers. What's more, profits for put sellers are capped at the premium received, while profits for call buyers are theoretically unlimited. Investors will generally experience more losing trades buying calls, but the profit potential is much greater. If call buyers are accurate in their prediction of the stock's movement before expiration, they can collect profits of 100 percent or greater. With put selling, profits tend to be much lower. For example, if an investor purchased the near-the-money November 32.50 call on Cisco Systems (CSCO), the value of his or her investment would grow if CSCO rallies into expiration. The profit potential on this position is theoretically limitless because the stock's upward potential is unlimited. However, if a trader sold the out-of-the-money CSCO November 30 put at a bid price of 3.80, his or her profits are limited to the premium received, or about 3.8 points.
Thanks for your question, and good luck in your trading.
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Question Level Key
Level One--Basic Jargon, Definitions, Basic Mechanics of Trading.
Level Two--Introductory Points, Practical Points and Simple Strategies
Level Three--More Advanced Strategies and Repairs
Level Four--Risk Management, Psychology, and How Best to Evaluate Things.
Level Five--High end questions concerning Portfolio Analysis, Managing a Portfolio
of Options, Option Pricing Models, and Nuances of Trading. Included could be a variety of
other topics.
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