The two main types of options are:
- Call Options: Give the holder the right to buy the underlying asset at the strike price
- Put Options: Give the holder the right to sell the underlying asset at the strike price.
Call Option
Gives the buyer the right to buy the underlying asset at the strike price before or at expiration. Owners of call options generally expect the stock to increase in value, while sellers of call options generally expect the stock’s value to decrease or remain the same.
Buying a call option gives you the right, but not the obligation, to buy 100 shares of the underlying stock at the designated strike price. The value of a call option tends to appreciate as the value of the underlying stock increases.
Selling a call option allows you to collect the premium while obligating you to sell 100 shares of the underlying stock to the owner at the agreed-upon strike price if the owner of the contract chooses to exercise the contract.
Example:
For example, you think ABC's upcoming quarterly earnings release is going to send the price of the stock soaring, so you buy a call for ABC at a $10 strike price with a $1 premium (the cost of the contract) expiring in a month.
- Symbol: ABC
- Expiration: A month from now
- Strike price: $10 per share
- Premium: $1 per share
- Size: 100 shares
You bought 1 call contract for $100. The earnings release gave the stock an increase, and the day your contract expires, ABC hits $15. This means you can sell the contract in the market for at least $5 per share and earn at least a $4 profit per share. So you've made a total profit of $400 on the contract (selling it for $500 less the cost paid of $100).
The day of expiry the contract is worth at least $5 because you could exercise the contract to buy the shares at $10, then sell the stocks in the market at their current trading price of $15.
Put Option
Gives the buyer the right to sell the underlying asset at the strike price before or at expiration. Owners of put options generally expect the stock to decrease in value, while sellers of put options generally expect the stock’s value to increase or remain the same.
Buying a put option gives you the right, but not the obligation, to sell 100 shares of the underlying stock at the designated strike price. The value of a put option tends to appreciate as the value of the underlying stock decreases.
Selling a put option allows you to collect the premium, while obligating you to purchase 100 shares of the underlying stock from the owner at the agreed-upon strike price if the owner of the contract chooses to exercise the contract.
Example:
For example, you think XYZs upcoming quarterly earnings release is going to send the price of the stock down, so you buy a put for XYZ at a $10 strike price with a $2 premium (the cost of the contract) expiring in a month.
- Symbol: XYZ
- Expiration: A month from now
- Strike price: $10 per share
- Premium: $2 per share
- Size: 100 Shares
You bought 1 Put option contract for $200. The earnings release gave and the price of XYZ dropped to $6. Your put option is now worth at least $4. So you can sell it in the market for a $200 profit (Selling it $400 - $200).