Options Trading Calls and Puts

Do you know what options are? Options are contracts in the financial world on some trading asset, including stock shares, bonds, commodities, mortgage loans, etc. There are a large number of possible assets that can have options. There are always common features of an option, however. They all have a contract feature which specifies what the option owner has contracted in the agreement, for starters.

What is a “call”? A call tells the option contract holder that he has the right to buy an asset at a stated price on or before a set expiration date. These option owners have a right to buy the asset then, but they are not obligated to do so. The call owner can always let his options expire, hence the term “option.” If he chooses to not buy, he will lose the initial money put down in the original agreement.

Call buyers are analysts who bet that the asset will increase in price before the expiration date. In this way, the price will rise enough to make the buyer a profit. The price, however, must rise enough to cover the difference between the strike price (what the stock must be bought at) and the current market price. The option itself costs money, so the price has to cover these costs as well. The cost to cover the option is called the premium.

The premium or cost of an option is determined by several influential factors, including the strike price, the expiration date of the option, the price of the asset itself and other items. The expiration time is very important since you will see less risk the longer you have to buy the option. For example, an option that lasts 90 days has less risk associated than one with only a few days remaining since 90 days gives you plenty of time to see the price increase enough to generate a profit.

When you have a share whose market price is above the strike price, you are “in the money.” You will be able to have money available. If the market price is lower than the strike price, on the other hand, you are “out of the money.”

What is a put? A put gives the option buyer the ability to sell the asset before a specific date at a particular price. Again, they have the right to do this; they are not obligated to sell at this time.

Puts are also very similar to shorting stock since the put buyers are betting that the stock price is going to fall before the option expires and not make any money. Have you gotten the sense that a lot of this is gambling in a way? This is also known as educated gambling.

If the market falls below the specified strike price, then you will profit from the put option. The option holder will be considered “in the money” if that happens. If you want to be a great investor, you will have to do your homework. The best investors love to research their companies, but no matter what, options trading is a very risky and complicated way to make money when compared to traditional stock trading. Unless you are a savvy investor, it’s best to avoid options trading whenever possible.

         

More Options Trading Glossary Articles