Why Are Call and Put Options Considered Risky?

As with most investment vehicles, risk is inevitable. Options contracts are considered risky due to their complex nature, but knowing how options work can help reduce the risk level. Call options and put options essentially come with the same degree of risk.

Depending on which "side" of the contract the investor is on, risk can range from a small prepaid amount of the premium to unlimited losses. Investors who know how each work helps determine the risk of an option position.

What Is an Options Contract?

"Puts" and "Calls" are two types of options contracts. Both can be purchased to speculate on the direction of a security or hedge exposure or sold to generate revenue.

A call option is a financial contract that gives the buyer the right to buy a stock, bond, commodity, or other asset or instrument at a specified price within a specific period. A put option is a contract giving the option buyer the right, but not the obligation, to sell—or sell short—a specified amount of an underlying security at a predetermined price within a specified time frame.

Level of Risk

In order of increasing risk, the long call option poses the least amount of risk as compared to the naked call option, which relies on the movement of the market price to determine the cost and risk to the investor.

• Long Call Option: Investor A purchases a call on a stock, giving them the right to buy it at the strike price before the expiry date. They only risk losing the premium they paid if the option is not exercised.
• Covered Call: Investor B, who wrote a covered call to Investor A, takes on the risk of being "called out" of their long position in the stock, potentially losing out on upside gains.
• Covered Put: Investor A purchases a put on a stock they currently have a long position in. Potentially, they could lose the premium they paid to purchase the put if the option expires. They could also lose out on upside gains if they exercise and sell the stock.
• Cash-Secured Put: Investor B, who wrote a cash-secured put to Investor A, risks the loss of their premium collected if Investor A exercises and risks the full cash deposit if the stock is "put to them."
• Naked Put: Suppose Investor B instead sold Investor A a naked put. Then, they might have to buy the stock, if assigned, at a price much higher than market value.
• Naked Call: Suppose Investor B sold Investor A a call option without an existing long position. This is the riskiest position for Investor B because if assigned, they must purchase the stock at market price to make delivery on the call. Since the market price can be infinite in the upward direction, Investor B's risk is unlimited.

The Bottom Line

Options contracts are considered risky due to their complex nature, but investors who know how options work can reduce their risk. Various risk levels expose investors to loss of premiums, gains, and market value loss.