There comes a time in every trader’s life that they venture into the realm of Options. The very first thing that they learn is what Puts and Calls are. Here’s a very simple and straightforward explanation to “What are Puts and Calls?”.
First, we’ll start with what Options are.
What Are Options?
Options are contracts. They are contracts between a buyer and a seller to exchange Stock at a certain price, on a specified date. The buyer of the Option has the right, but not the obligation, to purchase or sell Stock (depending on the type of Option).
The seller of the Option receives money from the buyer, in exchange to take on the obligation of the buyer’s right.
Each Option controls 100 shares of stock. So if an Options buyer decides to exercise their right, they buy/sell Stock in 100 share clips.
Why Do Options Exist?
Options exist as a way to hedge adverse Stock movements in a portfolio. If you are Long a Stock, and want to hedge against a downside move, you can buy a Put to protect yourself.
Not only that, but they are a great way to speculate on a Stock’s future price movement. You can limit your downside by purchasing Options, increase your odds of profitability by selling Options, or do a combination of both.
A Call Option is an agreement for the buyer of the Option to purchase Stock from the Options seller at a specific price, on a specific date. The qualification here is that on that specific date in the future, the Options Strike Price must be below the Stock’s current price.
A Put Option is an agreement between both the buyer and seller that allows the buyer to sell Stock at a specific price, on a specific date in the future. The qualification is that on that specific date, the Put Options Strike Price must be above the current price of the Stock.
For more information on Strike Prices, you can check out this article here.
You Can Buy ‘Em… You Can Sell ‘Em
With Stocks, you can both be Long Stock and Short Stock. With Options, it’s a similar situation. Not only can you be the Options buyer, but you can also sell them. How do sell something that you don’t first own? It’s simple.
Keep in mind that you are creating an agreement with another person when trading Options. You create the agreement when you sell the Option.
- If you’re Bullish, you can:
- Buy a Call Option
- Sell a Put Option
- If you’re Bearish, you can:
- Sell a Call Option
- Buy a Put Option
Selling Put Options is actually a popular way to boost returns, while mimicking buying Stock.
Why Would You Buy An Option?
Every Option controls 100 shares of Stock. If you wanted to take a position in a Stock, you could use an Option to mimic the price movement of the underlying Stock with reduced buying power.
For instance, if you wanted to buy 100 shares of Apple at $175/share it would cost you $17,500. A Delta 70 Call Option with 30-days until expiration would cost you about $700. This frees up the capital you have at risk, and your maximum loss is limited to the cost of the Option.
Not only that, but you can increase your gains by purchasing more Options and thus controlling more Stock. However, Options are depreciating assets. So keep in mind that you use Options to trade and hedge, not to invest.
Why Would You Sell An Option?
Options are depreciating assets. The closer they get to expiration, the less valuable they become. This is unfortunate for the buyer, but great for the seller. If the Option expires out-of-the-money, the seller gets to keep all the money received.
Moreover, you get to choose how far out-of-the-money you want to sell an Option. If a Stock is trading at $150, you could sell a Put at $145, $140, $135, etc. The farther out-of-the-money an Option, the lower the odds it gets exercised. Conversely, the higher the odds you’re profitable on the trade as an Options seller.
There’s a number of strategies involved with selling Options. These strategies are great if you’re looking to make consistent returns, with a high probability of profit. For more information, you can sign up for our free mini-course on Options, or you can jump ahead to our video course that goes over these strategies plus more in great detail (worth the money).
Or you could do neither. You’re a living, breathing, decision-making human being for crying out loud. You do what you want… But seriously in terms of detail and what you get for the money, you won’t find anything like the course we offer. No matter your level of experience, you will benefit and find value in it. Up to you. *Plug over*
I hope this was helpful to those who were looking to gain a better understanding of what Calls and Puts are. Options are very dynamic and there’s an infinite number of ways that they can be used.
They’re great for not only hedging and speculating, but also for creating consistent returns that trading outright Stock couldn’t offer.
Anyhow, that about sums up this article. I would love to hear your thoughts in the comments below. Or, if you think I missed anything in this article, please let me know and I’d be happy to add it and expand on it.