When thinking about options, it can get very complicated to determine if you are bullish or bearish about a stock, depending on which side of the trade you’re on.
The diagram Greg drew perfectly encapsulates the sentiment you should have depending on which of the four positions you take.
Note the colors: red and green. Red is bad (loss) and green is good (profit). Your contract position for the call or put can be in the money (ITM), or out of the money (OTM). Finally, you are either a bull or a bear for the stock. Bulls want the stock to go up and bears want the stock to go down. Yes, you can make a profit on rooting for a stock to go down! This is the beauty of a market at work.
Buying a Call 🐂
If you are a bull in the stock market, you generally want the value of your stocks to go up. You would “go long” and buy something that would go up over a long time. Buying a call is like buying a stock. You are hoping the stock goes above the strike price before the expiration date so you can sell the option for a profit. It is considered ITM (in the money) when the value of the stock exceeds the strike price set by the call option. You are a bull in this case.
Buying a Put🐻
Buying a put is like “shorting” a stock. You are hoping the value of the stock declines and goes below the strike price. You get to be ITM (in the money) when the value of the stock is lower than the strike price before expiration. You are “bearish” in this scenario, and want the value of the stock to go down while you’re holding the put contract. If the value of the stock goes below the strike price, you now have the right to sell it to the buyer a higher price than the market is currently offering.
Selling a Call 🐻
Selling a call is very interesting. You are betting the value of the stock goes down. You are a bear here. For the buyer, they want it to go up and they will profit and be ITM (in the money) when it’s above the strike price. For you the seller, you want the stock to go down. The buyer will pay you a premium immediately when the transaction begins. You, as a seller are betting that the value of the stock goes down below the strike price so you get to keep the whole premium you received and the buyer you sold it to lets expire worthless. You win when the call is said to be OTM (out of the money). Some sellers already own the stock they are selling the call against. This is known as a Covered Call. If you don’t own the stock and are selling a call, it’s said to be a naked call. (Naked Calls are very high risk and no Money Viking would ever touch these. If you are on the wrong side of the bet and the stock pops (goes up really high really fast), there is the risk you might not have the money or the shares in your account to cover, you will be forced to take a high interest loan from your brokerage until you can come up with the money to pay them back. This is known as a Margin Call.)
Selling a Put🐂
If you think selling calls are interesting, you’re going to love selling puts! You are a bull here, and you will win (i.e. keep the premium you received) when the value of the stock goes up. You are getting paid to take on the obligation that you promise to buy the stock at a very low price should it hit that price. Some smart folks might even sell puts against stocks they wish to buy anyhow. It’s sort of win-win in a way… if you don’t get the stock for cheap, you get to keep the premium. If the stock goes lower than the strike price, you end up being assigned, and must purchase the stock at the super cheap price you promised you would buy it at. It sounds too good to be true, but the risk is you might be buying a stock that plummets in value. Why did it go below your strike price? Was it temporary market volatility, or was it a biotech that just missed their FDA approval and you’re stuck with a dud? The same safety tip applies to selling puts as selling calls. Without the cash in your account to cover these transactions should the stock go down below the strike you run the risk of a margin call. Always have the cash secured to sell puts. You don’t get the premium for nothing!
I hope the above summary and Greg’s awesome cartoon help. I’ve printed out a high resolution version and taped it over my monitor to set me straight when I forget which side of the contract to take. Also interesting is that it helps you realize that selling a call and buying a put are both related in the sense you are a bear. Conversely, buying a call and selling a put are both bearish, and express the same sentiment.