Call And Put Options Can Make You Money

Call And Put Options

Puts and calls are the names of two different stock options. Very similar in their characteristics except that one is normally used if an investor believes a stock will go up, and the other if he believes a stock will go down.

A “call” option is a tradable security that gives the buyer the right, but not the obligation, to *buy* a stock by a known date for a certain price. A put option is the opposite: it gives the purchaser the right, but not the obligation, to sell stock by a certain date for a known price. The three main characteristics: stock, price, date, are all agreed to in advance by both parties.

The ‘date’ of an option contract is the expiration date. It is the last day that the holder of the option can exercise his right to buy (for calls) or sell (for puts). After that date he cannot because the option has expired. When buying options it is important to keep this date in mind at all times — if the investor is expecting some price action due to an earnings announcement then he needs to make sure the expiration date is after the expected announcement date.

All options have a ‘strike price’ which is the agreed to price where the option is exercisable on or before the expiration date. It is a kind of threshold before a transaction would take place on expiration day. For example, if a put option has its strike at 50 then the holder (buyer) of that option would not exercise his right to sell (or put) it unless the stock was below 50. Because if the stock was above 50 (the strike price) then he would do better by just selling the shares in the open market, rather than exercise his put. Similarly for calls, if the stock finishes above the strike on expiration day then the buyer of the call option will exercise, and if the stock is below the strike he will not.

Time premium and intrinsic value are two terms that describe the components of an option’s value in the market place. Intrinsic value means the stock price is above (for calls) or below (for puts) the strike price. The other piece of an option’s value is called extrinsic value, more commonly known as time premium. It represents the amount an investor would pay to take a risk that the stock price will move up (for calls) or down (for puts) by more than that amount between today and expiration day. This value is negotiated between the buyers and sellers of options.

Calls and puts can be used for rapid gains in a short period of time. If an investor believes a stock will rise quickly then he would buy a call option. If he guesses wrong, though, then he could lose all of his investment by the expiration date of the option. Likewise, if an investor thinks a stock will go down in a short period of time then he could buy a put option. If the stock does finish lower than the strike price by expiration then he may have a profit (depends on how much he paid for the put).