Should You Buy Calls or Sell Puts? Both Are Bullish Options

Regular readers of my columns know that I've been wildly bullish on shares of United Natural Foods . That's been the right move, as the shares have made great strides in recent months. The stock rose from south of $15 in December to as high as $41.37 on Monday. Since then, it settled back a bit on profit taking. As of early afternoon on Tuesday, UNFI was offered at $35.77. That represented a $5.60 decline of 13.5% from this week's peak. That pullback appears strictly technical. The company's latest quarter came in well above even the most optimistic estimates. Management signed up substantial new customers, negotiated a 5-year extension of its contract with Whole Foods Market, its largest account, and paid down debt. Additionally, earnings per share guidance for the fiscal year ending July 31, was set $3.55, the highest end of the previously stated range. My take is that fiscal 2022 could see UNFI earning close to $5 per share on increased sales, lower interest expense and improving net profit margins. If that plays out, the current price is just over seven-times where I see EPS by the end of July 2022. Growing earnings, along with the potential for significant price-to-earnings expansion leads me to think UNFI could trade up to from $80 - $100 within 18-months. That goal is not far fetched. United Natural peaked above $76 during the three years 2013, 2014, and 2015 on EPS ranging from $2.19 to $2.86. Those who agree could just own the stock and wait for it to move higher. Option-minded traders, though, have other choices to take advantage of what could become a major upturn. They could buy call options or sell put options. Both strategies are betting on UNFI heading higher. Risk and reward characteristics for each technique, though, are very different. Here were the actual option prices out to Jan. 20, 2023 when UNFI was selling at $36.31. Buying calls requires only a relatively small cash outlay. That appeals to traders with less than huge trading assets. It offers very large potential gains if things work out well. Unfortunately, call buying also means accepting a potential loss of up to 100% of your investment. Here's a chart showing the potential gains or losses on UNFI Jan. 20, 2023 $55 calls if they were purchased for the, then current, $10.20 price per share. Any expiration day close of $55 or lower would result in the dreaded 100% loss of principal. Ouch. A close at $60 would still sting. Call buyers at $55 would see 52% losses. Even a close at $65, up $28.69 per share, or up 79%, from the trade inception price of $36.31, would result in a 2% loss. At a final price of $70, profits would total 47%. At $80 that rises to 145%. An $85 final price would deliver a nifty 188% gain. Hitting $100, which is not at all out of the question, the $55 call owner could pocket about 341% on his original cash outlay, turning each $1,020 into $4,500. Call buying offers limited risk only in the sense that no more than 100% of the money invested can be lost. There are lots of ways to lose it all, but a few outcomes that could turn out exceptionally well. In theory, there is no upper limit on how high UNFI might reach by Jan. 20, 2023. Moves well above $100 would produce even more dramatic gains than detailed here. Let Me Put It This Way... Put writing (or selling) is a whole different animal. Option traders who sell puts must stand ready, both emotionally and financially, to be put the shares in question at the strike price selected. That typically only happens at or near the option's expiration date but it can theoretically occur at any time. Put writers don't need to lay out any cash up front. They do, however, need to have adequate cash and/or free buying power in a margin-type account to allow their brokerage firm to know they could pay for any shares that do get exercised. In our example they collected a cool $2,800 per 100-share commitment for standing ready to buy UNFI, if exercised later. The worst-case, net cost of the shares would drop to just $27 ($55 strike price minus the $28 put premium). Thus UNFI could fall by up to $9.30 per share -- a 25.6% drop -- from the trade inception price without causing a loss. I call that cushion the put sale's margin of safety. Here are the possible results for Jan. 20, 2023 expiration date $55 strike price puts if sold for $27 and held right through expiration day. What really jumps out at you is the high probability of success. Any closing price of at least $27 would cause no damage as the shares could be immediately liquidated even if put to you. Even a $30 final price would make for a $3 per share profit. The numbers get better as UNFI's final price goes higher. At $55 or above the put seller would capture their best-case scenario gain of $28 per share or $2,800 per 100-share commitment. That's pretty cool considering they never actually would have put out any cash along the way. Profitability would be capped at that level, however, no matter high much above $55 UNFI might be on expiration day. Put writing offers a high probability of winning. It requires no upfront cash outlay. Margin requirements on put sales, though, mean small sized accounts are not typically eligible to employ this strategy. There are two major downsides to selling puts. Potentially having to buy stocks which are already trading below your break -even point. Needing adequate cash or buying power to pay for shares put to you due to adverse market action. There you have it. Both techniques seek to benefit from a rising stock price. Each has a very distinct, and different risk/reward profile. Only you can decide which choice, or perhaps neither, suits you best. (Note: This article has been updated from an earlier version.)

Should You Buy Calls or Sell Puts? Both Are Bullish Options

Here I'll review the two options using UNFI as an example.

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