Put vs call options: the difference, with examples

Written by the Tactfolio research teamPublished 5 min read

A call option gives you the right to buy a stock at a set price before a set date. A put option gives you the right to sell a stock at a set price before a set date. People buy calls when they think a price will rise. They buy puts when they think a price will fall, or to protect shares they own.

Key points#

  • A call is the right to buy. A put is the right to sell.
  • The buyer pays a price up front, called the premium. The most a buyer can lose is that premium.
  • The seller collects the premium but takes on a duty. Sellers can lose far more than they collect.
  • One standard US stock option covers 100 shares.
  • Every option has an end date. After it passes, the option is gone.

Risk note. Options can expire worthless. Selling options can lose far more than the premium you collect.

What is the difference between a put and a call?#

The difference is direction. A call pays off when the stock goes up. A put pays off when the stock goes down.

Call optionPut option
Buyer gets the right toBuy 100 sharesSell 100 shares
Buyer hopes the stock willRise above the strike priceFall below the strike price
Seller mustSell shares at the strike if askedBuy shares at the strike if asked
Most the buyer can loseThe premium paidThe premium paid
Most the seller can loseNo limit, unless they own the sharesStrike price × 100, minus the premium
A common useBet on a rise with less moneyProtect shares from a fall

The strike price is the price written into the option. The expiration date is the last day the option is good. These terms come from the SEC’s investor site, Investor.gov.

How a call option works: an example#

Say a stock trades at $50. You think it will rise. You buy one call with a $55 strike price that expires in two months. The premium is $2 per share. One contract covers 100 shares, so you pay $200.

Here is what can happen at expiration:

  • The stock ends at $50. No one would pay $55 for a $50 stock. The call expires worthless. You lose $200.
  • The stock ends at $57. The call is worth $2 per share ($57 minus $55). That is $200, so you break even.
  • The stock ends at $65. The call is worth $10 per share, or $1,000. You made $800 on $200.

So your break-even price for a call is the strike plus the premium. Here that is $55 + $2 = $57.

How a put option works: an example#

Now say the same $50 stock worries you. You buy one put with a $45 strike that expires in two months. The premium is $1.50 per share, so you pay $150.

  • The stock ends at $50. No one would sell at $45 when the market pays $50. The put expires worthless. You lose $150.
  • The stock ends at $43.50. The put is worth $1.50 per share ($45 minus $43.50). You break even.
  • The stock ends at $35. The put is worth $10 per share, or $1,000. You made $850.

For a put, the break-even price is the strike minus the premium. Here that is $45 minus $1.50 = $43.50.

Buying vs selling options#

Every option has a buyer and a seller. Their risks are very different.

The buyer pays the premium and gets a right. If things go wrong, the buyer loses only what they paid.

The seller (also called the writer) collects the premium and takes on a duty. A call seller may have to sell shares at the strike price. A put seller may have to buy shares at the strike price. If the stock moves hard the wrong way, the loss can be many times the premium.

Selling a call while you own the shares is called a covered call. It is one of the most common ways people sell options, because the shares cover the duty to sell.

What moves an option’s price?#

Three things matter most:

  1. The stock price. Calls gain value as the stock rises. Puts gain value as it falls.
  2. Time left. Options lose value as the end date gets closer. This loss is measured by theta.
  3. Expected swings. When traders expect big moves, options cost more. This is called implied volatility.

These measures are part of the options Greeks, a set of numbers options traders use. The Options Industry Council explains each one.

Common mistakes#

  • Buying cheap calls far from the stock price. They are cheap because they usually expire worthless.
  • Forgetting the premium. A stock can rise and a call can still lose money if it does not rise past the break-even price.
  • Selling options without knowing the worst case. A call sold without the shares has no loss limit.
  • Ignoring time. Even when you are right about direction, you can be wrong about timing.
  • Trading options before your broker approves you. US brokers must approve each account for options and hand you the official risk booklet first (FINRA).

Try it on Tactfolio#

Tactfolio does not trade options. It builds and tests rules for stocks and funds. Some people buy puts to guard against a crash. One idea without options is a trend rule. It moves to safer assets when the market falls below its long-term average. The Faber 10-month moving average model does this with the S&P 500. You can open it, read every rule, and see its hypothetical backtest, including the years it lagged. You can also build your own version in the strategy builder.

Common questions#

Is it better to buy a put or a call?#

It depends on what you expect. A call profits if the stock rises past the break-even price. A put profits if it falls below it. Both lose the full premium if the stock does not move far enough in time.

Can you lose more than you invest with options?#

When you buy a call or a put, the most you can lose is the premium. When you sell options, you can lose much more. A call sold without owning the shares has no upper limit on losses.

What does it mean to be “in the money”?#

A call is in the money when the stock is above the strike price. A put is in the money when the stock is below the strike price. An in-the-money option has value if used right now.

Why do people buy puts on stocks they own?#

To protect against a fall. A put sets a floor price for the shares until it expires. It works like insurance, and the premium is what the insurance costs.

What happens when an option expires?#

An option that is in the money at expiration is usually used automatically by the broker. An option that is out of the money expires worthless. Check your broker’s rules before the last day.

Sources

Put it into practice