In their most basic form, buying options enables a trader the right, but not the obligation, to take some form of action, such as buying or selling shares of an underlying stock, by a specific predetermined date.
There are two kinds of options – call options and put options. Likewise, there’s two sides to every option trade. There’s the party buying the option and the party selling, or writing, the option.
If you purchase a call option, you have the right to buy shares at the underlying asset’s strike price until the expiration date. You don’t, however, have an obligation to purchase the underlying shares. You could do absolutely nothing and have your option expire worthless.
If you sell, or write, a call, however, there’s an obligation to sell your share of the underlying asset at a specific price. This is assuming the call buyer decides to buy those shares. Therefore, you purchase a call option on ABC stock with a strike price of $20, you have the right to exercise that option and pay $20 per share, should you decide to purchase ABC shares at that price. And, if you want to, then the call writer, or seller, is obligated to sell their shares of ABC stock at the $20 price.
When you buy a call option you’re intending to profit when the price increases. Conversely, the price of the call option will rise as the underlying shares of stock go up. When you write, or sell, a call you’re hoping for just the opposite. You’ll profit more if the price drops.
If you purchase a put option, you have the right to sell your underlying shares at a set price. Conversely, if you sell a put option, you’re obligated to purchase shares of the underlying stock at the set strike price should the put buyer decide to sell their shares.
If you buy a put option you’ll profit when the price of the underlying stock falls. And, the value of a put option goes up when the price of the underlying stock falls. Therefore, if you write, or sell, put options you’re hoping for the option to expire with the price of the underlying stock still above the option’s strike price.
It’s important to check market trends and stock directions before placing any trade. You need to decide what side of the coin you want to be on – buying or selling. There’s the opportunity to make money on either side, but different perspectives can be better depending on if the market is up, down, or sideways. Similarly if a put or a call fits the market better.
So take some time to decide if calls or puts fit your trading style better, and then get yourself as acquainted with them as possible. If you want to see the two types of options in action consider trying a $7 trial month with us here at Simpler Trading and jumping in the live trading room. Being a member of Simpler Trading gives you the opportunity to find out what types of trades best fit your style so you can be successful going forward.