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What are Call and Put Options?

Jim B.
Jim B.

Call and put options are the two main opportunities available to individuals who wish to make investments on the options market. A call option gives the investor who buys it the option, although not a binding responsibility, to purchase 100 shares of the stock underlying the option at some point before the contract's expiration date. By contrast, a put option gives the investor the right to sell those 100 underlying shares. Both call and put options may be bought and sold on the options market.

Option trading takes great skill and expertise from investors, who must speculate on the movement of a security and determine when the security is going to make that move. Even though it can be daunting in its intricacy, the options market can represent a huge opportunity for an investor who understands its inner workings. Great gains can be made that can conceivably dwarf the profits available from simply trading stocks. Call and put options represent the two main trades made on the options market.

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To understand call and put options, it is necessary to understand some of the terminology involved in options trading. The premium is the amount paid for the contract, while the strike price is a price set at the onset of the contract either above for call options or below for put options the current price of the underlying stock. At any point before the predetermined expiration date of the contract, the buyer of the contract may exercise the option once the stock price reaches the strike price. If the strike price isn't reached, the contract is worthless for the buyer.

With call options, the strike price is set above the current price, and the contract is said to be in the money once the price rises above the strike price. The opposite is true for the put price, with the contract in the money at the point at which the underlying stock price descends below the strike price, which is set at a lower level than the current price at the outset of the contract. When an option goes in the money, it becomes profitable for the buyer, who may then exercise the option at any point up until the expiration date.

For both call and put options, the buyer is only at risk for the premium paid for the contract. Sellers of call and put options can conceivably suffer much bigger losses if the stock price heads significantly into the money. The basic premise of option trading is that the buyer of a call option anticipates that the underlying stock price will rise, while the buyer of a put option believes that the underlying stock price will fall.

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