You must have heard about people making money from stocks. To make money with a stock, there are two basic options: buy it (call option) or sell it (put option). Call and put are called options as there is no obligation on your part to carry out the transaction and they are merely an option for you. But at the end of the specified period, you can exercise your options if they bring profit to you.
What Is A Call Option?
- An agreement that gives the investor the right to buy(not obligation) the stock at a specified price(strike price) within a specified date(expiry date).
- If you exercise call option, you enter into a contract with a broker that authorizes you to buy a stock at a price anticipated by you at a specified date. This price is known as strike price. If your anticipation is right and the stock prices rise more than the strike price, you have the right to get them at the strike price which is how you make profit through call option. Let us take an example. If you entered into a contract with a broker at $10 that you would buy a company’s stock at $200 which is currently priced at $190 before the end of the month, and if the price of the stock goes up to $220, you can exercise your right and buy the stock at the strike price of $200 thus making a profit of $20 per share and can sell them at the market price of $220 thus earning a huge profit if you buy a large stock. The seller only gets $10 which is a part of the bargain. However, if the price of the stock remains below Two hundred at the expiry of the date of the contract, you have the option of not buying the stock, thus losing only $10 in the bargain.
What Is A Put Option?
- Put option is just the opposite of a call option and here you strike a bargain to sell shares at the strike price. If the prices of the share do fall below the strike price, you can buy them from the market at the prevalent prices and then sell them to the buyer at strike price thus making money. For example, if the stock is priced at $100 today and you enter into a put option with a broker saying you would sell the shares at a strike price of $95 at the end of the month. Now if the price of the stock goes down to $90 at the end of the month, you can buy the shares from the market and then sell them to the broker at a higher strike price thus making a good profit.
There are two sides to every option transaction — the party buying the option, and the party selling (also called writing) the option. Each side comes with its own risk/reward profile and may be entered into for different strategic reasons. The buyer of the option is said to have a long position, while the seller of the option (the writer) is said to have a short position.