Options trading can be a complex and risky strategy, but it can also offer significant rewards for those who understand how it works. Two of the most common types of options are calls and puts. In this article, we’ll explain how calls and puts work and how they can be used in options trading.
What are calls and puts?
Calls and puts are types of options contracts that give the buyer the right, but not the obligation, to buy (calls) or sell (puts) an underlying asset at a specified price (strike price) within a specified time period (expiration date).
When you buy a call option, you are buying the right to purchase the underlying asset at the strike price before the expiration date. This can be a profitable strategy if you believe the price of the underlying asset will rise above the strike price before the expiration date.
When you buy a put option, you are buying the right to sell the underlying asset at the strike price before the expiration date. This can be a profitable strategy if you believe the price of the underlying asset will fall below the strike price before the expiration date.
How do calls work?
Let’s say you buy a call option for a stock with a strike price of $50 and an expiration date of one month from now. The premium (price) of the option might be $3. This means you pay $3 per share for the right to buy the stock at $50 per share within the next month.
If the price of the stock rises above $50 per share before the expiration date, you can exercise your call option and buy the stock at the lower strike price of $50. You can then sell the stock on the open market at the higher market price, making a profit.
If the price of the stock does not rise above $50 per share before the expiration date, you can choose not to exercise your call option and let it expire. In this case, you lose the premium you paid for the option, but you are not obligated to buy the stock.
How do puts work?
Let’s say you buy a put option for a stock with a strike price of $50 and an expiration date of one month from now. The premium (price) of the option might be $2. This means you pay $2 per share for the right to sell the stock at $50 per share within the next month.
If the price of the stock falls below $50 per share before the expiration date, you can exercise your put option and sell the stock at the higher strike price of $50. You can then buy the stock back on the open market at the lower market price, making a profit.
If the price of the stock does not fall below $50 per share before the expiration date, you can choose not to exercise your put option and let it expire. In this case, you lose the premium you paid for the option, but you are not obligated to sell the stock.
Calls and puts are two common types of options contracts that can be used in options trading. Calls give the buyer the right to buy an underlying asset at a specified price before the expiration date, while puts give the buyer the right to sell an underlying asset at a specified price before the expiration date. Both types of options can be used to profit from changes in the price of the underlying asset, but they can also be risky and complex. It’s important to do your research and understand the risks before trading options.