Calls vs Puts

I had an interesting exchange in a Yahoo! Finance Group where I’m a member yesterday and then Kadena commented and posed the similar question early today on this blog.  I figured the topic of calls vs puts was worth covering a little deeper without covering more advanced strategies of combining two or more of these in straddles, strangles, etc.

This is my view of how calls differ from puts.  First I think it’s important to start by grouping the similarities.  Selling covered calls is similar to selling naked puts regarding risk and return.  Both lose money for the investor when the stock declines and both have capped profit potential.

Buying puts and buying calls offer similar risks and rewards to an extent, but offer opposite returns when the underlying stock drops or climbs. With a put you can only gain the value of the underlying stock and with a call you have unlimited upside.

Kadena asked “how similar is buying a call to selling a put? When you attempt to find good equities which will not get put to you, yet yield solid premium plays, how successful do you think a call buy on one of your plays would be?”  Call buying is very different than put selling. 

On occasion call buying would have been the right move for me instead of selling puts as I did.  On RVBD and AAPL for example I sold covered calls and they both made huge moves up.  I’m still making my solid returns I started off with, but could have made much more.  On average, selling covered calls works better for me since the stocks usually gain less than I make in premiums.  Also, since some of my picks go down, my premium earned helps to even it out compared to the losses I would have taken if I had bought calls.  Speaking of Lenny Dykstra and baseball, I think of my approach as going for lots of base hits rather than any home runs.  With my personality, I prefer to have lots of small hits and fewer strike outs.

My friend who commented the other day has been debating calls vs puts with me for years.  He loves the the massive % gains he makes on a regular basis.  I can’t stomach the massive % losses he takes on a regular basis.  I don’t think there is a single answer for which is better.  Which option you choose is really up to your financial goals and risk tolerance. 

Since I know my risk tolerance is not too great per stock (funny but I don’t mind the risk of using margin) and I like the consistent hits I clearly have a bias for covered calls and naked puts.  The risk and reward is theoretically the same for each so the question is which to use.  For me, I like naked puts because it doesn’t tie up my cash.  I can use that cash that would have been used to buy the underlying stock to earn interest in my account while the money idly sits as a back up for any stocks assigned.  This interest earned is shown generally in the disparity between premiums of calls and puts at-the-money. Occasionally you can find a stock that has a more bullish or bearish sentiment and the premiums become skewed towards the general consensus.

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