Bearish Outlook

Purchasing put options or selling call options to protect oneself?

Martin Noël
April 11, 2017
6 minutes read
Purchasing put options or selling call options to protect oneself?

Is it better to purchase put options or to sell call options for protection against loss? Many investors ask this question but, in this as in many areas, there is no single right answer. As we have seen in earlier articles, purchasing options has one major disadvantage: the erosion of the time value that must be counterbalanced by a corresponding gain in the intrinsic value in order to remain at break-even and not lose money. It becomes clear that purchasing options is all about synchronicity, i.e. with a very specific price objective on a particular share, purchasing options becomes interesting, because the performance-risk ratio can be calculated precisely. For example, an investor believes that ABC shares that are trading at $20 will rise to $22 in the next two months. Here, two goals are set: the price, and the time period over which the strategy will be implemented. Let us assume that call options expiring in two months are offered at a price of $0.50 per share. We can calculate the potential profit if the target price is attained ($1.50 per share) and compare it to the potential loss of $0.50 if the strategy does not work out. The performance-risk ratio stands at 3 to 1. Thus, the investor could choose to go with this strategy, fully informed and able to judge whether chances of success are sufficiently high. With a precise price objective and a well-defined timeframe, purchasing options can easily be justified, as we have seen. However, how would it be if anticipated price declines scale and duration are unknown? To answer this question, I would like to examine the following situation about the publicly-traded iShares S&P/TSX 60 (XIU) fund.

I chose to analyze a period where, at first sight, it seems that purchasing put options is profitable. As we can see on the previous chart, such period would be from April 17, 2015 to January 22, 2016. Initially, XIU was trading at $22.55 and decreased to $18.34, showing a loss of $4.21. Knowing the outcome, it is now easy to determine what would have been the best put option to buy to maximize profit. As is said, hindsight is always 20/20. However, let us go back to April 17, 2015, when a decline is anticipated, but both its scope and duration are unknown. In my analysis, I have compared purchasing put options as close to parity as possible to selling call options for the same exercise price. Both options expire the following month. All positions are kept until expiration, when they are closed out and rolled over into the next expiration, the cycle repeating until January 22, 2016. Dividends that could have been paid or any possible premature assignment were not taken into account.

Date XIU Calls Call Prices Puts Put Prices $ XIU $ Calls $ Puts
2015/04/17 22,55 XIU 150515 C 22.50 0,31 XIU 150515 P 22.50 0,32
2015/05/15 22,16 XIU 150515 C 22.50 0 XIU 150515 P 22.50 0,34 -0,39 0,31 0,02
2015/05/15 22,16 XIU 150619 C 22.25 0,20 XIU 150619 P 22.25 0,33
2015/06/19 21,33 XIU 150619 C 22.25 0 XIU 150619 P 22.25 0,92 -0,83 0,20 0,59
2015/06/19 21,33 XIU 150717 C 21.25 0,36 XIU 150717 P 21.25 0,27
2015/07/17 21,62 XIU 150717 C 21.25 0,37 XIU 150717 P 21.25 0,00 0,29 -0,01 -0,27
2015/07/17 21,62 XIU 150821 C 21.50 0,41 XIU 150821 P 21.50 0,31
2015/08/21 20,04 XIU 150821 C 21.50 0 XIU 150821 P 21.50 1,46 -1,58 0,41 1,15
2015/08/21 20,04 XIU 150918 C 20.00 0,52 XIU 150918 P 20.00 0,56
2015/09/18 20,20 XIU 150918 C 20.00 0,2 XIU 150918 P 20.00 0,00 0,16 0,32 -0,56
2015/09/18 20,20 XIU 151016 C 20.25 0,4 XIU 151016 P 20.25 0,46
2015/10/16 20,50 XIU 151016 C 20.25 0,25 XIU 151016 P 20.25 0,00 0,3 0,15 -0,46
2015/10/16 20,50 XIU 151120 C 20.50 0,44 XIU 151120 P 20.50 0,43
2015/11/20 19,95 XIU 151120 C 20.50 0 XIU 151120 P 20.50 0,55 -0,55 0,44 0,12
2015/11/20 19,95 XIU 151218 C 20.00 0,31 XIU 151218 P 20.00 0,36
2015/12/18 19,38 XIU 151218 C 20.00 0 XIU 151218 P 20.00 0,62 -0,57 0,31 0,26
2015/12/18 19,38 XIU 160115 C 19.50 0,26 XIU 160115 P 19.50 0,53
2016/01/15 17,85 XIU 160115 C 19.50 0 XIU 160115 P 19.50 1,65 -1,53 0,26 1,12
2016/01/15 17,85 XIU 160219 C 17.75 0,6 XIU 160219 P 17.75 0,49
2016/01/22 18,34 XIU 160219 C 17.75 0,83 XIU 160219 P 17.75 0,24 0,49 -0,23 -0,25
-4,21 2,16 1,72
Source : Montreal Exchange

As you can tell from the previous table, the repeated purchasing of put options during that period was indeed profitable, with a gain of $1.72. However, surprisingly enough, selling call options was the most profitable venture, with a gain of $2.16. Although it is impossible to draw definitive conclusions from just one example, this result does not surprise me the least, since I have noticed, through my work, the effectiveness of option sales. Indeed, there have been many analyses on the subject, including one by the Chicago Board Options Exchange (CBOE) that compares several option sale strategies amongst themselves.

In conclusion, the main lesson to be learned from this analysis is that with a definite goal price and a particular period in mind, options purchasing offers a leverage effect that can be beneficial. However, if, in the long term, we have no precise picture of the scale and duration of a trend, it could be better to consider strategies that take advantage of the erosion of the time value before diving into purchasing options.

Good luck with your trading, and have a good week!

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.

Martin Noël
Martin Noël


Monetis Financial Corporation

Martin Noël earned an MBA in Financial Services from UQÀM in 2003. That same year, he was awarded the Fellow of the Institute of Canadian Bankers and a Silver Medal for his remarkable efforts in the Professional Banking Program. Martin began his career in the derivatives field in 1983 as an options market maker for options, on the floor at the Montréal Exchange and for various brokerage firms. He later worked as an options specialist and then went on to become an independent trader. In 1996, Mr. Noël joined the Montréal Exchange as the options market manager, a role that saw him contributing to the development of the Canadian options market. In 2001, he helped found the Montréal Exchange’s Derivatives Institute, where he acted as an educational advisor. Since 2005, Martin has been an instructor at UQÀM, teaching a graduate course on derivatives. Since May 2009, he has dedicated himself full-time to his position as the president of CORPORATION FINANCIÈRE MONÉTIS, a professional trading and financial communications firm. Martin regularly assists with issues related to options at the Montréal Exchange.

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