What is a Call on a Put?

A call on a put is a type of compound option. It gives you the right to buy a put option later if you need it. You pay some money now to have the choice to get the put option in the future.

Why Would You Want One?

You might want a call on a put if you’re not sure right now whether you’ll need a put option. A regular put option lets you sell a stock or something else at a set price by a set date. If the stock price goes down, the put becomes worth more money.

Buying the call on the put now means you don’t have to pay the full price for the actual put option today. You only pay that bigger chunk of money for the put if it turns out you need it after all.

An Example of How It Works

Let’s say a stock is trading at $100 today. You think it might drop to $80 in the next three months. You could buy a put option that lets you sell the stock for $100 anytime in the next three months.

If the stock does fall to $80, your put option is worth $20 since you could buy the stock for $80 and sell it for the $100 strike price. But the put costs a fair bit of money. And if you buy it now, that money is gone even if the stock doesn’t drop and you never use the put.

Instead, you could buy a three-month call on that put. The call would cost much less than the put itself. If the stock stays above $100, you’ll just let the call expire. You won’t use it to buy the put.

But if the stock starts to fall and drops under $90 after two months, you could use your call to buy the put, and then use the put to sell the stock for $100. You’ll be glad you bought the call option so you can get the put when you need it.

The Decision to Buy a Call on a Put

Choosing to buy a call on a put comes down to whether you think you might need a put option in the future. It depends on how likely it is the stock or other asset will fall.

You Need Some Downside Protection

The main reason to consider a call on a put is because you have a stock or something else and you want to protect against it losing value. This is called hedging. The call on the put is a cheaper way to buy that protection compared to getting the put outright.

You have time before you need to decide. The call option gives you a few months or more to see whether the put will be useful to you. During that time, if the stock goes up, you won’t end up wasting money on a put you don’t need.

Weighing the Potential Outcomes

To decide if a call on a put is a good move, think about what could happen. Make your best guess at the chances the stock will fall enough to make the put valuable.

Compare the cost of the call to how much you could save or gain by using it to get a put later on. The more likely a big drop looks, the more it makes sense to spend on the call on the put.

Also think about how much the call costs compared to buying the put itself. The call should be meaningfully cheaper to be worth it. You’re paying for the benefit of waiting to see if you need the put. That has value, but only to a point.

Some Real World Considerations

Before you go out and buy calls on puts, make sure you understand the details of how they work. The exact terms matter and they can get a bit complicated.

Strike Prices and Expiration Dates

Calls on puts have two layers of strike prices and expiration dates. The call part has its own expiration date and strike price for the underlying put.

Then if you use the call to buy the put, the put you get also has a strike price and expiration. Make sure both sets of terms line up with your expectations for when you might need the hedge and what stock price you’re trying to protect.

Your Broker and Trading Costs

Not all brokers or investment platforms give you access to compound options like calls on puts. You may need to open an account with a broker that specializes in options. And even then, you might need special approval to trade these complex instruments.

Also pay attention to the trading costs. Since you’re making at least two trades (buying the call and then maybe the put), those commissions can add up. Factor that in when you’re weighing the value of the strategy.

Taxes and Regulations

Depending on where you live and the specifics of the options, there could be special tax rules involved. In the U.S. for example, compound options can sometimes get taxed differently than regular options.

There are also some extra regulations around things like how much money you need in your account to trade compound options. Make sure you understand and follow all the rules.