Ask the Institute

DATE: March 31, 2014

QUESTION:

Can you explain the difference between buying a put option and selling a call option?

ANSWER:
Look at a P&L diagram of a long put option, which is the same as buying a put. Compare it to a P&L diagram of a short call option. As you can see, the profit & loss of the long put and the short call are very different. The long put has substantial profit potential, limited risk and a breakeven point below the scenario’s current stock price. The short call, however, has limited profit potential, unlimited risk and a breakeven point above this example’s current stock price.

Regardless of what a trader does, the difference in the profit & loss diagrams reveal the differences in market outlooks for the buyer of a put option and the seller of a call option. These diagrams show that the long put is truly a bearish strategy, but the short call is a neutral-to-bearish strategy. To learn more about the difference between buying a put option and selling a call option, view this segment of "Ask the Institute."