Options: Calls and Puts

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Call and put options are examples of stock derivatives - their value is derived from the value of the underlying stock. For example, a call option goes up in price when the price of the underlying stock rises. And you don't have to own the stock to profit from the price rise of the stock. A put option goes up in price when the price of the underlying stock goes down.

As with a call option, you don't have to own the stock. But if you do, the options puts and calls definition acts as a hedge - as the stock price goes down, the value of the put goes up so you are hedged against the downside.

You make money on options if your bet on the direction of price movement of the underlying stock is correct. If not, you'll probably loose most or all the money you paid for the option. Options are very sensitive to changes in the price of the underlying stocks.

Like gambling you can make or lose money very quickly. Because option prices change options puts and calls definition rapidly, owning them requires that you spend a significant amount of time monitoring price changes in the stock and the option. And if you're wrong about the price movement, be prepared to lose all or a significant portion of the money you paid for the options.

A call is a contract that gives the owner the right, but not the obligation, to buy shares of a stock at a fixed price, called the strike price, on or before the options expiration options puts and calls definition. If the value of the stock goes down, the price of the option goes down, and you could hold it or sell it at a loss.

The price that you pay for a call option depends on many factors two of which include: See the following videos: If you own a stock, you may buy a put as a form of insurance. If the stock falls in price, the put rises in price and helps offset the paper options puts and calls definition in the underlying stock. If you don't own the stock but think it will go down in price, you buy the put to profit from the decline in price of the stock. If the stock price declines, the value of the put rises and you would sell the put for a profit.

If the stock increases in price you may sell the put for a loss. A put option is a contract that gives you the right, but not the obligation, to sell a stock at a preset price. The price that you pay for a put option depends the duration of the contract the longer the duration, the more you pay and how far the current price of the stock is from the strike price of the contract.

Put buying is different from selling short. With a put option your only liability is the price you paid for the put. With a short sale, you have an unlimited downside liability if the stock goes up. Also, the proceeds from selling short are in a options puts and calls definition account so you have to pay interest and meet margin requirements.

Buying puts is a more conservative way of betting on a stock declining in price. Options puts and calls definition a Call For every buyer of a call there must be a seller, who assumes that the stock price will remain flat or go down. The seller collects the purchase price of the option but has the obligation to sell shares of the stock if the buyer decides to exercise the option.

If the seller gets called - he must sell the stock. If the stock continues to appreciate in price after options puts and calls definition stock is sold, the seller looses the future price gain. In most cases you must own shares of the stock for each contract you sell - this is called a covered call. Therefore, if your stock gets called away, you have the shares in your account.

You can sell covered calls to generate a stream of income. If the stock price does not rise enough during the period of the contract, you won't get called and won't have to sell the stock so you keep the money you received when options puts and calls definition sold the call. If your broker lets you, you may sell "uncovered "or "naked" calls in a margin account. This practice lets you sell calls when you don't own the stock. If you get called, options puts and calls definition must buy the stock at its current market value to cover the call even when the market price is higher than the strike price of the option.

Like any margin account transaction, you must execute the transaction immediately. The seller of a put collects the purchase price of the option from the buyer of the put. The seller has the obligation to buy shares at the strike price regardless of the market value of the underlying stock.

So if the put buyer decides to exercise the put contract, the seller of the put has to buy the shares at the strike price no matter the current market value of the stock. When you sell a put, you want the price of the stock to go up so you don't get the stock put to you - buy the stock for more than it's worth. Selling a put places the options puts and calls definition you receive in a margin account so you pay interest on the proceeds until the put contract is closed.

If you don't have the financial resources to cover the obligation of buying the stock from the buyer of the put, you sold "naked puts". It tells about a trader who sold naked puts and experienced financial ruin. It was an unhedged bet, or what was called on Wall Street a "naked put" On October 27,the market plummeted seven per cent, and Niederhoffer had to produce huge amounts of cash to back up all the options he'd sold at pre-crash strike prices.

He ran through a hundred and thirty million dollars - his cash reserves, his savings, his other stocks-and when his broker came and asked for still more he didn't have it. In a day, one of the most successful hedge funds in America was wiped out. Niederhoffer was forced to shut down his firm. He had to mortgage his house. He had to borrow money from his children.

He had to call Sotheby's and sell his prized silver collection Use calls and puts judiciously. If you're right, you can make quick money. If you're wrong, you can lose part or all of your investment very quickly. Do not sell "naked" options. You may be inviting a financial disaster. Knowledgeable, experienced investors may want to sell covered calls and puts to collect other peoples money. Because the price of options can change very quickly and dramatically, you must continually watch their price movement.

If you not prepared to do so, don't buy or sell options. Alternative Actions for the Call Buyer. Alternative Actions for the Put Buyer. Alternative Actions for the Call Seller. Alternative Actions for the Options puts and calls definition Seller. What the call buyer may do.

Exercise call option if the stock price rises above the strike price. Buy shares at strike price, which is less than market price buy stock for less than it's worth. Exercise option if the stock price declines. Sell options puts and calls definition at strike price, which is more than market price sell stock for more than it's worth. Put buyer must own shares to sell. Can already own them or buy them at market price, which is less than strike price.

What the call seller may do. Sell shares at the strike price to the call buyer if the call buyer exercises the call option. If the call seller already has shares in his account, they are sold to the buyer at the strike price.

If the call options puts and calls definition does not have shares, he must buy the shares on the open market at a price greater than the strike price.

What the put seller must options puts and calls definition. Buy shares from the put buyer if the put buyer exercises the put option. If the put seller already has money in his account to buy the stock, the put option options puts and calls definition covered. If the seller does not have money to buy the stock, the put option is naked. The put seller must come up with money to buy the stock.

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A call option , often simply labeled a "call", is a financial contract between two parties, the buyer and the seller of this type of option. The seller or "writer" is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides. The buyer pays a fee called a premium for this right. The term "call" comes from the fact that the owner has the right to "call the stock away" from the seller.

Option values vary with the value of the underlying instrument over time. The price of the call contract must reflect the "likelihood" or chance of the call finishing in-the-money. The call contract price generally will be higher when the contract has more time to expire except in cases when a significant dividend is present and when the underlying financial instrument shows more volatility.

Determining this value is one of the central functions of financial mathematics. The most common method used is the Black—Scholes formula. Importantly, the Black-Scholes formula provides an estimate of the price of European-style options.

Adjustment to Call Option: When a call option is in-the-money i. Some of them are as follows:. Similarly if the buyer is making loss on his position i. Trading options involves a constant monitoring of the option value, which is affected by the following factors:. Moreover, the dependence of the option value to price, volatility and time is not linear — which makes the analysis even more complex. From Wikipedia, the free encyclopedia.

This article is about financial options. For call options in general, see Option law. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. October Learn how and when to remove this template message.

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