2 questions about puts/calls/shorting

Question

I have 2 questions about puts/calls + shorting in my learning about options.

1. I'm confused about how "short selling" a stock is the same/different as "writing a covered call." In my learning... it seemed that there were multiple ways that an institution could act if they think a stock is going to go down. 2 of these I'm pretty certain exist, but it just clicked that this 3rd way might be one of the other two...

a) Buy to open on a put option ("Buy > Put" in Robinhood)

b) Sell to open by "writing a covered call" ("Sell > Call" in Robinhood)

c) Now... this third one is leftover remnants from many different articles I've read online trying to understand this. It seems like these guides allude to some method where an institution asks the the broker for shares to borrow, sometimes illegally, and then once they get them, those shares now get marked in the "short interest" percentage. Then, they have to buy to close to exit.

It just occurred to me that this 3rd option, which was always different in my mind (and in my mind wasnt even an "option" requiring 100 shares), actually must be alluding to item b) ... is that correct? Are there more than 4 combinations (buy call, write call, buy put, write put)... or is that it? Are huge hedge funds and institutions just using these 4 methods, or is there a 5th or more method for "shorting" stocks? I guess it threw me off with the "illegal" bit (which Im assuming no online broker lets you do), and the "asks broker for shares" part, rather than robinhood where you literally just create your own contracts. On top of that, all these stupid examples use 10 shares or 5 shares or 1 share so it makes it seem like its something OTHER than an option, as they never say 100.

2. If I choose one of the 2 "short" options... some guides make it sound like I can "buy back" that option even after someone bought it from me. Am I misunderstanding? I know the other party can exercise, but it made it sound like someone could buy to open ... hold that contract, but then I could revoke it or sell it or something and it would get it back. This seemed counter intuitive (ie it must expire, or the buyer has all the power). Maybe I misunderstood

Answer 1

Here's the big picture and I leave it to you to fit it into various aspects of your question.

1. Buy a put. On an expiration basis your break even is the strike price less the premium paid. For example, buy a $50 put for $2. Break is $48. Make money below $48. Lose money above $48. Prior to expiration the P&L is different (see an option pricing formula). This is a bearish position.

2. Buy a call. On an expiration basis your break even is the strike price plus the premium paid. For example, buy a $50 call for $2. Break even is $52. Make money above $52. Lose money below above $52. Prior to expiration the P&L is different. This is a bullish position.

3. Sell a covered call (synthetically equivalent to selling a put). On an expiration basis your break even is the strike price less the premium paid. For example, buy stock at $45 and sell a $50 call for $2. Break even is $43. Lose money below $43 and make a maximum of $7 if the stock rises. Prior to expiration the P&L is different. This is a neutral to mildly bullish position, depending on the strike price sold.

4. Buy the stock. Make $1 for every $1 the stock rises and lose $1 for every $1 the stock drops. This is a bullish position.

5. Short sell the stock. Ignoring dividend issues and borrow cost, make $1 for every $1 the stock drops and lose $1 for every $1 the stock rises. This is a bearish position.

There are other more complex combinations of the above strategies.

Any option position that you own can be closed by you before expiration unless your option is exercised and you are assigned.

With all due respect, avoid options until you clearly understand what they about. Read a few option books. Doing so might save you a chunk of money.