# Call vs Puts: a short position can profit using both depending on strike price?

I'm confused about whether you want to own a call or put if you believe a stock price will go down.

Most articles have described owning Puts as betting the stock will go down, and calls as betting the stock will go up.

Ex: Owning the right to sell shares at \$60 when the stock price is \$50. (ignoring for premium). You profit when you exercise the put.

However, can you also profit using a call?

Ex: Owning the right to buy at \$40 when the stock price is \$50. You profit when you exercise the call (and sell the stock, or maybe sell the call). (ignoring for premium).

Am I missing something here, as all the articles and videos describing options have exclusively described calls as longs, and puts as shorts.

• "All the articles and videos describing options have exclusively described calls as longs, and puts as shorts." You need to find a better source of option info if that's their description. Commented Jul 2, 2018 at 12:01

So you are asking if you buy a call option for a stock whose price is currently \$50 but the call allows you to pay \$40 for it, can you make a profit if the price falls?

It is theoretically possible but impractical. If the stock price is currently \$50, then the call seller should charge at least \$10 for a call at \$40. If the stock goes down in price but stays above \$40, you can exercise the call. But you will have lost money overall if you paid \$11 for a call at \$40 if the price is now \$45. You've paid \$51 for something that is currently valued at \$45. It still may make sense to exercise the call, as the \$11 is lost at this point. You might as well get back \$5 if you can.

If you expect the stock to fall, you should sell a call at \$40 for \$11 (assuming that's the market clearing price). Then if the stock goes below \$40, you make \$11. If the stock goes down to \$45, you make \$11 + \$40 - \$45 = \$6. You only lose money if the stock prices goes to \$51 or higher.

It is theoretically possible that you could buy a call at \$40 for less than \$5 when the stock price is \$50. But as a practical matter, it is unlikely. You could simply execute the call immediately at \$40 and sell it for \$50, making at least \$5. So why would anyone sell that call?

Another reason to think that buying a call is a long position, is that it becomes more profitable as the stock price increases. And less valuable as the stock price decreases, until the stock reaches the price of the call.

Now, if you happen to find a stock at \$20 and buy a call at \$40 for \$1, you might eventually profit after a downturn. The price could go up to \$60 and then drop to \$50. You exercise at that point, buying for \$40. You sell for \$50, making a \$9 profit. But you would have been better off selling at \$60. You made a profit, but not as much of one as you could have made if the stock didn't fall.

In general, you can't ignore the cost of the option. Until you purchase or sell the option, the cost is part of the prospective profit or loss. Once you've bought, then you care whether it is in-the-money or not rather than whether it is profitable. But you can't buy calls for a large premium, exercise them in-the-money, and be guaranteed of making a profit. You will lose money on in-the-money options whenever the option cost more than the amount you were in-the-money.

TL;DR: Buying a call (or selling a put) is a long position because it is more valuable as the stock price increases. Selling a call or buying a put is a short position because either becomes more valuable as the stock price decreases.

• The only theoretically possible way to pay \$5 for a long call with \$10 of intrinsic value would be a fat fingered bad trade. No one sells such calls since they present the immediate opportunity for Discount Arbitrage. Large pending dividends depress call premiums so ITM calls expiring shortly (but after the dividend) may trade at a discount to intrinsic value which is \$10 for a \$40 call strike when the stock is \$50. Commented Jul 2, 2018 at 11:18

I think you're confusing whether an option is in-the-money with whether it's a profitable position. Being in-the-money means an option has intrinsic value that you can extract by selling or exercising. But profit depends on what you paid for the option. Calls have positive delta, so when the stock goes down their value also goes down. You would need to be short a call option to profit using calls in this case: Sell the call high, then buy it back low.

• Sure, so to simplify things, lets just refer to being "in the money". A put with a strike price above market price is in the money and can be exercised. A call with a strike price below market price is also in the money? If so, why do articles/videos not describe shorting with calls? Is there something with the pricing mechanisms that discourage it? Commented Jul 2, 2018 at 5:12
• @user339946 Yes, the call you describe is in-the-money, but the problem is that it's worth less than it was when the stock was higher. Shorting, like any trade, seeks to benefit from changes in prices over time. So you need to consider not just one moment in time, but two: when you enter the position and when you exit it. What's key is not the absolute price of the option, but how it responds to moves in the stock. A simple example: A call with a strike of zero is equivalent to the stock itself (ignoring dividends). So buying the call is a bet that the stock will go up. Commented Jul 2, 2018 at 5:39
• "Why do articles/videos not describe shorting with calls? Is there something with the pricing mechanisms that discourage it?" --- Long and short options have asymmetric risk/reward. Shorting options has a limited reward and a large risk. For a short call, it's as high as the stock can go and for a put, it's limited by the stock hitting zero. If your info source isn't making this clear, you need a better one. If you really want to have a good understanding of option strategy, read McMillan's "Options As A Strategic Investment". Commented Jul 2, 2018 at 12:07

A call option gives you the right but not the obligation to buy the underlying at a specified price within a specific time period. If you buy a call with a strike price of \$50 when the underlying is \$50, then as the underlying price moves up so does the value of the call.

If the underlying price moves to \$60, you can exercise the call and buy the underlying for \$50 then sell the underlying on the market for \$60, or you can sell the call back before expiry for a profit.

If on the other hand the price of the underlying falls to \$40, the value of the call will lose value and would expire worthless (because there is no use exercising the call and paying \$50 for the underlying when the underlying is currently worth \$40).

A put option gives you the right but not the obligation to sell the underlying at a specified price within a specific time period. If you sell a put with a strike price of \$50 when the underlying is \$50, then as the underlying price moves down the value of the put moves up.

If the underlying price moves to \$40, you can exercise the put and sell the underlying for \$50 (you could either sell your previously bought underlying for \$50, or buy the underlying at the current market price of \$40 and sell it for \$50 when you exercise the put).

If on the other hand the price of the underlying rises to \$60, the value of the put will lose value and would expire worthless (because there is no use exercising the put and receiving \$50 for the underlying when the underlying is currently worth \$60).

You have received three other replies explaining the P&L of options at expiration. They're all correct but just be aware that prior to expiration, the options may not necessarily behave exactly as described since the other option pricing variables may come into play and they may affect the option's price (cost of carry for the underlying, pending dividends and implied volatility).

One thing I'd add is that it is almost always better to sell your long option rather than to exercise it. If it has any time premium remaining, you throw that away by exercising. Also, if you exercise, you incur more frictional costs because there are more transactions (B/A spreads and commissions).

The only time that you should exercise your option is if you want a long or a short position in the stock or the call is deep ITM and it is trading below intrinsic value. The latter is particularly noticeable before a large pending dividend.

Share price is reduced by the amount of the dividend on the ex-dividend date by the stock exchanges. Because the stock price is expected to drop by the amount of the dividend on the ex-dividend date, high cash dividends imply lower call premiums and higher put premiums (call premium is discounted while put premium expands). Since call owners do not receive the dividend, this discount may be exacerbated by owners selling their calls before ex-div. This may result in the call trading at a discount below parity, aka below intrinsic value. For example:

XYZ is \$40

July \$35 call is \$4.80

The intrinsic value of the call is \$5.00 . When you sell the call for \$4.80, you are taking a 20 cent haircut. The market maker buys your call, shorts the stock at \$40 and immediately exercises the call to buy the stock at \$35 (-4.80 + 40.00 - 35.00 ) netting + 20 cents.

If you have the funds available, you should do this yourself, assuming that your commission costs are low. At a broker that provides free assignment and exercise, you have one commission either way that you do it and exercise is the more profitable exit.