Get Out The Very Nice Difference Between A Call Option And A Put Option By Supernsetips.
If you have dabbled in the investing world for any period
, you have undoubtedly listened claims about people making money from stock options. However, stock options are quite different than the stock which underlies them. With a stock, there are two basic options : buy it or sell it. With options, there are contracts at many different strike prices and expiration dates. At any given time, there may be hundreds of options for each individual stock. This article will assist you see the two basic types of options : Calls and Puts.
1. What is a Call? .
A call option is a contract. There are two sides to this contract, and you can enter the contract on either side that you wish. The buyer of a call has the option to purchase a stock if it reaches a previously agreed upon price. The seller of the call has the obligation to sell the stock if it reaches the agreed upon price.
Example :.
Stock trades at $100.
The price of the call option is $5.
The Strike Price is $100.
The expiration date is January 21, 2011.
A buyer and a seller of the option enter into a contract with each other. Typically, the contract is settled on the day after the option expires. Basically, one of two things can happen. Either the stock will be above $100 dollars, or it will be below $100 dollars. If the stock is below $100, then the option buyer won't want to buy the stock for that price, since he can simply buy it cheaper straight from the market. In that case, the option seller keeps the $5 he sold the option for.
If the stock closes above $100, then typically the option holder will buy the stock for that price. He can then either choose to hold the stock or sell it on the open market. In this case, the option seller still gets to keep the $5 premium he was paid for his end of the contract.
In this example, the option buyer would require the stock to arise to $105 in order to see a profit. Since he paid $5 for the opportunity to buy the stock, he would need to make more than that on the trade in order to show a profit. If the stock closes at $110, then he would show a profit of $110 - $100 - $5 = $5 per share. Since he only invested $5 to begin with, this represents a 100 % profit in a short period of time.
For this reason, options can render investors with dramatic gains if the stock price rises quickly in a short period of time. But then, if the stock had closed at $100 or less, he would have lost all his money on this trade.
2. What is a Put? .
A put option is similar to a call contract, except that the roles are changed by reversal. With a put, it is the buyer of the put who has the option to sell, and the seller of the put who has the obligation to purchase.
Let's run through the same example, this time with a put.
Stock trades at $100.
The Price of the Put option is $5.
The Strike Price is $100.
The expiration date is January 21, 2011.
The primary reason that someone may want to buy a put is to insure his stock. If an investor owns the stock in question, he might be cared that the stock might drop sharply if the company reports a bad quarter. So he might buy a put at a strike price of $100, which would guarantee him the power to sell his stock for $100 on January 21, 2001, even if it has dropped down to $50. If it closes above $100, then again, the option expires as worthless and the put seller pockets the $5. In this case, the put seller acts as the insurer of the stock, and the put buyer is buying insurance for his stock, just as someone might buy insurance on their home for a little fee.
Options are powerful and useful instruments which can be practiced for many different purposes based on your investment strategy. It is worth noting that approximately 80 % of all options run out without ever reaching the strike price, which implies that being a seller of options is a much better strategy than to be a buyer. However, that is a discussion for a different article.
by: Karena Lam
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Get Out The Very Nice Difference Between A Call Option And A Put Option By Supernsetips. Anaheim