Call Writing Vs Put Writing – What’s The Difference?

Know the difference between Call writing vs put writing: Generally while investing in the stock market, you will come across a lot of volatility and protect yourself from the short-term volatility in the market, the market has provided us with something called options that help us hedge our risk. Options consist of two parties which are the buyer and the writer.

In this article, we will cover the writer’s side of options and discuss Call writing vs Put writing.

What Is An Options Contract?

An options contract is a type of derivative contract whose value is derived from an underlying asset. This contract is made between the parties namely, the buyer and the seller/writer for a future date at a predetermined price.

In this contract, the buyer gets the right but not an obligation to execute the contract on or before the expiration date. For this choice, the buyer of the contract will have to pay a premium to the writer while entering into the contract.

The seller/writer on the other hand is giving up the right of execution and is obligated to execute or not execute the contract depending on the choice made by the buyer. The writer receives a premium from the seller for giving up this right.

For the buyer, the loss is limited to the premium paid with the potential to earn unlimited profit. For the writer, the profit is limited to the premium received with the potential to incur an unlimited loss.

What Is A Call Option?

A call option is a contract entered between two parties where the buyer of the contract gets the right to buy but not an obligation to buy the underlying asset on or before the expiration date.

What Is A Put Option?

A put option is a contract entered between two parties where the buyer of the contract gets the right to sell but not an obligation to sell the underlying asset on or before the expiration date.

What Is The Benefit Of Writing An Option?

With the above explanation, it is understood that the upside for the option writer is limited to the premium received and the loss can be unlimited. Then why do individuals opt for writing an option contract?

To explain in simple terms, the odds of winning while selling an option contract is much higher than buying an options contract. This is because of the time factor in options.

As the time comes closer to expiry, the price of the options contract keeps decreasing and eventually Out of Money Options turns to zero on the day of expiry.

So even if the price goes right in the direction of the buyer of the option, there is still a probability of the buyer losing due to time decay. This is the reason individuals go for writing an option contract.

Now that we have learned the benefit of writing an option contract, there is a dilemma of call writing vs put writing, which one to choose? Keep reading further to find out.

The Payoff In Call Writing Vs Put Writing

Although call writing and put writing are similar in nature, they can be differentiated by when they are written and when they break even. Let’s take a look at the payoffs for each of these separately.

Call Writing

A call option is written when the seller expects the price of the underlying asset to fall. The sellers of the call option are bearish in nature and they start losing when the price of the underlying asset starts increasing. Let us now look at the pay-off pattern of Call writing

Payoff for call option writer at different spot prices during expiry

As you can see from the above diagram, the maximum profit by the call option writing is limited to the premium received and the loss can be to the extent of a rise in the prices of the share. Losses can be to any tune while writing Call Options.

Put Writing

A put option is written when the seller expects the price of the underlying asset to rise. The sellers of the put option are bullish in nature and they start losing when the price of the underlying asset starts decreasing. Let us now look at the pay-off pattern of Call writing

Payoff for put option writer at different spot prices during expiry

As you can see from the above diagram, the maximum profit by the call option writing is limited to the premium received and the loss can to the extent of decrease in the share price. The losses can be huge even for the Writer of Put Option.

Also Read: Options Trading Vs Intraday Trading – Which is Better?

In Closing

In this article, we briefly discussed what are options, the benefits of writing options and the payoff in Call writing vs Put writing.

Through this article, we understood that call writing is entered with a bearish sentiment and put writing is entered with a bullish sentiment. Though the chances of going right in options are better, you should also remember that if the market doesn’t go in your favor, you’ll end up losing a lot of capital. Hence it is always advised to trade in options up to the extent of your risk appetite.

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