Options can be used by investors to protect their portfolios from losses. They can also assist in the purchase of a stock at a lower price than its current market value in order to maximize profits.
The two sides of options trading are the call vs put options, which allow traders to wager for or against the future of security. The following are the distinctions between the two.
What are calls and puts?
Options are contracts that provide the bearer the right to purchase or sell a predetermined quantity of an underlying asset at a predetermined price at or before the contract’s expiration date. Options, like most other asset classes, can be purchased through brokerage accounts.
Options are useful since they can improve a person’s portfolio. They do so by increasing their revenue, providing protection, and even using leverage.
What is a call option?
A call option gives investors the opportunity, but not the obligation, to acquire a stock at a predetermined price (the strike price) within a specified time frame (the expiration date).
Essentially, the buyer of the call gets the option to acquire the securities until the expiration date. The seller of the call is also known as the writer. The writer may sell the share at the strike price until the expiration date.
If a stock’s price is expected to rise, an investor may wish to purchase a call option. This would imply that they would obtain the stock at a reduced price. However, if the stock price falls below the strike price of the call option, the transaction may not make sense.
Call options are used by investors to capitalize on the upside of owning stock while minimizing risk. Assume an investor purchased a call option on stock ABC for $20 per share and has the option to exercise the transaction for up to two months. Even if the stock price rises, the writer can exercise this option for $20 until it expires.
What is a put option?
In contrast, if an investor acquires a put option, they will have the right to sell a stock at a predetermined price until the option expires. The investor who purchased the put option has the right to sell the shares to the writer at the agreed-upon price until the time period expires. The investor, however, is not required to do so.
Buying a put option is a strategy to protect yourself against a reduction in the share price. As a result, even if the stock price falls on a put option, they will escape further loss. A bear market or a drop in stock prices could potentially benefit the investor.
How does a call option work?
When the stock price is higher than the strike price at expiration, the call option is in the money. The call owner can exercise the option by putting money up to purchase the stock at the strike price. Alternatively, the owner might simply sell the option to another buyer for its fair market value.
When the premium paid is less than the difference between the stock price and the strike price, the call owner benefits. Assume a trader paid $0.50 for a call with a strike price of $20, and the stock is currently trading at $23. The option is worth $3, and the trader has made a $2.50 profit.
If the stock price is lower than the strike price at the time of expiration, the call is out of money and worthless. Any premium received for the option is kept by the call seller.
How does a put option work?
When the stock price is less than the strike price at expiration, the put option is in the money. The put owner has the opportunity to exercise it by selling the shares at the strike price. Alternatively, the owner can sell the put option to another bidder at fair market value before it expires.
When the premium paid is less than the difference between the strike price and the stock price at option expiration, the put owner profits. Assume a trader paid $0.80 for a put option with a strike price of $30, and the stock is $25 at expiration. The option is worth $5, and the trader has made a $4.20 profit.
If the stock price is higher than the strike price when the put expires, it is out of money and worthless. Any premium earned for the option is kept by the put seller.
What are the similarities between call and options?
Here below are some of the common similarities between call and options;
- Call and put options give you the right to buy and sell shares of stock at a set price during a specific period of time.
- Put option: Gives the holder the right to sell a number of assets within a specific period of time at a certain price.
- Both types of options come with the potential to earn and lose money on your investments.
What are the differences between call and put options?
The major difference between call options and put options is that the put option gives the holder the right to sell a number of assets within a specific period of time at a certain price while the call option gives them the right to buy assets under those same conditions.
Conclusion
When you know the basics of options, they don’t have to be tough to comprehend. When utilized correctly, options can be beneficial, but when used incorrectly, they can be destructive.
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