Stock Options—Puts Are More Expensive Than Calls

For almost every stock or index whose options trade on an exchange, puts (options to sell at a set price) command a higher price than calls (options to buy at a set price).

When comparing options whose strike prices (the set prices for the puts or calls) are equally far out of the money (significantly higher or lower than the current price), the puts carry a higher premium than the calls. They also have a higher delta, which measures risk in terms of the option's exposure to price changes in its underlying stock.

Price Determinants

One driver of the difference in price results from volatility skew (the difference between implied volatility for out of the money, in the money, and at the money options). The following example demonstrates how this works:

• Suppose the SPX (the Standard & Poors 500 Stock Index) is currently trading near $1,891.76.
• The investor buys a $1,940 call (48 points OTM) that expires in 23 days and costs $19.00 (using the bid/ask midpoint).
• Another investor buys a $1,840 put (51 points OTM) that expires in 23 days and costs $25.00 at the bid/ask midpoint.

The price difference between the $1,940 and $1,840 options is quite substantial, especially when the put is three points farther out of the money. This favors the bullish investor (one with an optimistic view of the market), who gets to buy single call options at a relatively favorable price. On the other hand, the bearish investor (one with a pessimistic view of the market) who wants to own single put options must pay a penalty, or a higher price, when buying put options.

Another item of concern for investors is current interest rates. Interest rates affect option prices, and calls cost more when they are higher. In 2019, interest rates hovered just under 2.5%, so it was not a factor for traders then.

So, why are the puts inflated (or calls deflated)? The answer is that there is a volatility skew:

• As the strike price declines, implied volatility increases.
• As the strike price increases, implied volatility declines.

Supply and Demand

Options have been trading on an exchange since 1973. Market observers noticed that even though markets were bullish overall, they always rebounded to newer highs. When the market did decline, the declines were, on average, more sudden and more severe than the advances.

You can examine this phenomenon from a practical perspective: Investors who prefer to always own some OTM call options may have had some winning trades over the years. However, that success came about only when the market moved substantially higher over a short time, and the investors were ready for it.

Most of the time, OTM options expire worthless (when they are less than the market value). Overall, owning inexpensive, far OTM call options proves to be a losing proposition. Thus, it is not strategic for most investors to own far OTM call options.

Owners of far OTM put options saw their options expire worthless far more often than call owners did. But occasionally, the market fell so quickly that the price of those OTM options soared, and they soared for two reasons.

How a Market Fall Affects Options

First, the market falls, making the puts more valuable. Second (and in October 1987 this proved to be far more important), option prices increase because frightened investors were anxious to own put options to protect the assets in their portfolios—so much so that they did not care or understand how to price options. Those investors paid egregious prices for those options.

Remember that put sellers understood the risk and demanded huge premiums for buyers being foolish enough to sell those options. Investors who felt the need to buy puts at any price were the underlying cause of the volatility skew at the time. 

Over time, buyers of far OTM put options occasionally earned a very large profit, often enough to keep the dream alive. But the owners of far OTM call options did not.

Far OTM owners lost enough that it was sufficient to change the mindset of traditional options traders, especially the market makers who supplied most of those options. Some investors still maintain a supply of puts as protection against a disaster, while others do so with the expectation of collecting the jackpot one day.

A Changing Mindset

After Black Monday (October 19, 1987), investors and speculators liked the idea of continuously owning some inexpensive put options. Of course, in the aftermath, there was no such thing as inexpensive puts, due to the huge demand for put options. However, as markets settled down, and the decline ended, overall option premiums settled to a new normal. 

That new normal may have resulted in the disappearance of cheap puts, but they often returned to price levels that made them cheap enough for people to own. Because of the way that option values are calculated, the most efficient method for the market makers to increase the bid and ask prices for any option is to raise the estimated future volatility for that option.

This proved to be an efficient method for pricing options. One other factor plays a role in pricing options:

• The further out of the money the put option is, the larger the implied volatility. In other words, traditional sellers of very cheap options stop selling them, and demand exceeds supply. That demand drives the price of puts higher.
• Further OTM call options become even less in demand, making cheap call options available for investors willing to buy far-enough OTM options (far options, but not too far).

The following table shows a list of implied volatility for the 23-day options mentioned in the example above.

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