[Options ABC] Considerations for Buying a Call or Selling a Put: Learn with ARM

Wordcount: 1500
Target Audience: Investors interested in option Greeks.
Main Content: What is buying a call? What is selling a put? What are the differences?

As the situation meets Alice's expectations, Alice will earn a profit of US$135 in option premiums.

In this scenario, Alice still has the potential to earn part of the option premium. If the stock price remains stagnant, the time value of the option will decay over time, causing the put option previously valued at US$135 to potentially depreciate to around US$100 or even US$80.
What options does Alice have?
She can choose to buy the same put option to close out her position and earn the difference in option premiums. However, it's crucial to note that the put option purchased for closing cannot be sold since the seller's contract made at the very beginning cannot be canceled. She is essentially buying to close her previously open options position.
Alternatively, if Alice decides not to buy the same put option, she may still make a profit. If the buyer exercises the option, Alice will be required to purchase 100 shares of ARM at the agreed-upon rate of US$49. After deducting the option premium she received earlier, her net cost per share may be lower than the market price. However, since the option writer was assigned, they now have the downside risks of owning the stock.

Whether Alice needs to return the option premium depends on how much the stock drops. If the price only decreases slightly on the expiration date, Alice will have to purchase 100 shares of ARM for US$49, minus the option premium she received earlier. In this case, her cost price may still be lower than the market price, which would allow her to make a profit (assuming she sells the stock after getting assigned the shares). However, if the stock price drops significantly, Alice's option premium may not cover the extent of the decline, and she could start losing money.
Therefore, in these three scenarios, Alice will experience losses when the stock price drops sharply and her option premium cannot cover the decrease and margin interests(If margin is used). Otherwise, she will likely either make a profit or break even.

As the situation falls short of her expectations, she will lose US$195 in option premium.

In this instance, Alice still faces losses. Why? If she exercises the option, she will purchase 100 shares of ARM at the price of US$49, which is equivalent to the market value of the stock. Moreover, she spent US$195 on option premium when opening the position, making purchasing the stock through the option more costly than buying it directly. Alternatively, if she chooses not to exercise the option, she loses the option premium of US$195 for nothing.

Whether Alice makes a profit depends on how much the stock price increases. If the market price exceeds US$50.95—the sum of the strike price and the option premium—Alice earns a net profit. However, if the market price doesn't exceed this threshold, Alice will face losses.
In summary, Alice will only make a profit if the stock price rises past her breakeven point by expiration in these three scenarios. Thus, selling Put options seems advantageous due to it having more favorable scenarios of ending with a potential profit.