Quick question, what is more risky selling puts or buying stock and selling calls against the stock position (covered call writing strategy or buy-write strategy)? If you said selling puts you would be wrong. If you answered the buy-write strategy, you’d be wrong as well. Actually these positions are equivalent according to put-call parity. Put-Call parity is the formula that defines the relationship between the price of a call option and a put option.

Selling Puts: The Payout

Think about it, when selling puts the options trader would receive premium for the sale and the amount of the premium collected would be the maximum amount of profit he could expect from the trade under all scenarios. If the stock jumped 100 points by expiration, the options trader would still only profit by the amount of the premium collected. However, on the downside, the options trader loses point by point after shares fall below the strike of the put that was sold. The trade turns negative once shares fall below the strike minus the put premium collected. So basically you have significant downside loss potential (bounded by zero) and limited upside potential (bounded by the put premium collected) when selling puts. What would this look like in diagram form? See for yourself below:

The Buy-Write (Covered Call Writing Strategy)

Let’s take a look at the dynamics of the buy-write strategy. Under this strategy the options trader goes long stock and shorts an upside call, collecting premium in exchange for potential profits from a significant increase in stock price. Thus, the investor bears full downside exposure to potential movement lower in stock price, and is capped in upside exposure by the difference between the stock price and strike price + premium collected. Sound familiar? What would the payout of the buy-write strategy look like, see below:

As you can see, the payout for the buy-write and selling puts strategies maintains an identical profile. So are there any advantages to selling puts over a buy-write / covered call writing strategy? In a word, YES. 3 of the main advantages of selling puts over a covered call writing strategy are highlighted below:

1. Less capital commitment: Selling puts requires the options trader to only post margin for a % of the max potential loss of the trade. Whereas the buy-write / covered call writing strategy requires the investor to purchase shares at the current market price minus the premium collected for the call sale. The lower capital commitment of the selling puts strategy allows the investor to utilize the capital, that otherwise would have been used to purchase shares, on other investing opportunities.
2. Lower transaction costs: This is as simple as 1 transaction (selling puts) vs. 2 transactions (buying stock, selling calls).
3. Hard-to-Borrow securities adds some juice to put implied volatility: The implied volatility of put options often maintain a higher implied volatility than would be dictated by put-call parity in circumstances where shares become hard to borrow. This scenario presents an attractive opportunity for options traders with bullish opinions on the stock to structure positive bias trades using options. Traders end up collecting more premium for the sale of put options on the stock presenting an even greater advantage to the selling puts strategy in comparison with the covered call writing strategy as the call implied volatility remains unaffected (or even lower than normal).

For further information on Selling Puts / Covered Call Writing Strategy and other Options Trading Strategies visit OptionsUniversity.com.