What are the advantages of writing (selling) versus buying a call?
You have seen on some plays we like to sell puts, on some we like to buy calls, and on some we do both. Given that, it is clear that writing puts and buying calls are strategies that both anticipate a rise in the stock. Each has advantages and disadvantages.
We like writing puts. For one thing, we don’t have to come out of pocket with any money. We sell a put, we get the cash in the account the next day. True, we cannot do anything with the cash as it is held as part of the margin requirement, but we are not having to pay for anything. We are getting paid for taking the risk. Moreover, unlike buying calls, when we sell puts, time becomes our friend. As time marches on, the value of the puts we sold decreases due to time decay. This is a great benefit. Stocks go up, down, or nowhere. The beauty of selling a put is that if we sell an out of the money put or an at the money put and the stock just goes nowhere, we win. If the stock goes up we win. If it goes down, we (can) lose. Buying a call, we have to have the stock climb or we lose. If it holds the same level, we are in trouble.
For example, look at the LU put play we had last expiration. The stock moved to a breakout, but did not do much. Time did its work, and when the stock moved up just a bit at expiration, we had a winner. On a call play, a small move like that at expiration would not have helped us at all.
Usually any time we would buy a call we could write a put. We really like writing puts on breakouts as the breakout price should act as support if the breakout was strong, and that helps protect you if the market sells back-the stock will tend to stay at or above support. When we write a put that was at the breakout price, we will most likely win if the stock does not break support.
All is not roses with put writing. For one thing, your upside is limited to the credit or premium you take in from selling the put. The stock could run up $100, but all you would get would be what you sold the put for. If you are able to consistently make 20% to 35% on your money each month writing puts, however, hitting the homerun is not that imperative. Another disadvantage is that of assignment. As you approach expiration and the puts you sold are in the money, you run a higher risk of getting the stock put to you. It can happen anytime prior to expiration. We can say that has never happened to us, but we know traders who have had stock put to them. That is one reason selling puts in your IRA requires 100% cash security. One thing we can do as we approach expiration is roll the position out to the next month. If we have the risk of assignment and don’t want to take a loss having to buy the puts back at a higher price, we can buy the puts back and sell the next month out. We will always get more for those as there is the time element built into the premium. If the stock is not in a total downtrend we can eventually win on the position when the stock rises. Another disadvantage is the margin requirement. This varies from broker to broker, but usually is 30% of what it would take to buy the stock if it was put to you. That money is dead money while the put is in play. That is one reason that if we get a strong move in the stock in the right direction, we will often buy our puts back if a lot of the premium has been drained out of them on the move-we won’t gain much more if we wait it out, we can buy them back and free the margin money up for plays that can make us more at that point in time than what we would gain by letting the put expire, and we eliminate the risk of assignment. One other disadvantage is that brokers often won’t let an investor write puts unless the investor has sufficient experience.
Even with the disadvantages, put writing can be very lucrative and given the benefits of having time work for you as opposed to against you, the fact that you can win even if the stock does not rise, and the ability to roll positions out to avoid a loss are powerful investment allies.
