Call options and put options are the two basic option types. They are similar except that one is primarily used when an investor thinks a stock will go up, and the other is used mostly when an investor thinks a stock will go down.
The definition of a call option is that it gives the holder the right to buy a certain stock by a certain date for a certain price. The key word is "buy", because a put option has the opposite meaning -- the right to sell a stock by a date for a price. When two investors enter a trade like this, both agree in advance on the stock, the date, and the price. The seller of such an option will receive "premium" (money) from the buyer of the option on the day they both open the trade.
With regards to expiration dates on options, there are two styles: American and European. With American style the holder of the option may exercise his right on any day prior to (and including) the expiration date. With European style options, the holder may only exercise his right on the expiration date. Sometimes with American style options the holder will exercise early (called 'early exercise') to capture a dividend that is about to be paid.
All options have a 'strike price' which is the agreed to price where the option is exercisable on or before the expiration date. It is a kind of threshold before a transaction would take place on expiration day. For example, if a put option has its strike at 50 then the holder (buyer) of that option would not exercise his right to sell (or put) it unless the stock was below 50. Because if the stock was above 50 (the strike price) then he would do better by just selling the shares in the open market, rather than exercise his put. Similarly for calls, if the stock finishes above the strike on expiration day then the buyer of the call option will exercise, and if the stock is below the strike he will not.
An options value in the market is made up of two parts: intrinsic value and time premium. The intrinsic value is the amount the option is "in the money". That is, for call options, if the stock is above the strike price, and for put options if the stock is below the strike price. Any additional value for the option would be ascribed to its "time premium" this is the about that will decay (reduce) as time passes, ending at zero on option expiration day. It is the source of income for investors who sell options.
People who buy call options are taking the risk that the underlying stock will rise above the strike price before the expiration date. If it does then they will be able to exercise their right and buy the stock at the strike price. Likewise, people who buy put options are taking the risk that the stock will fall below the strike price before the expiration date. This is sometimes called insurance because no matter how far the stock price falls the holder of the put will be able to sell his stock to the seller of the put for an amount equal to the strike price.
The definition of a call option is that it gives the holder the right to buy a certain stock by a certain date for a certain price. The key word is "buy", because a put option has the opposite meaning -- the right to sell a stock by a date for a price. When two investors enter a trade like this, both agree in advance on the stock, the date, and the price. The seller of such an option will receive "premium" (money) from the buyer of the option on the day they both open the trade.
With regards to expiration dates on options, there are two styles: American and European. With American style the holder of the option may exercise his right on any day prior to (and including) the expiration date. With European style options, the holder may only exercise his right on the expiration date. Sometimes with American style options the holder will exercise early (called 'early exercise') to capture a dividend that is about to be paid.
All options have a 'strike price' which is the agreed to price where the option is exercisable on or before the expiration date. It is a kind of threshold before a transaction would take place on expiration day. For example, if a put option has its strike at 50 then the holder (buyer) of that option would not exercise his right to sell (or put) it unless the stock was below 50. Because if the stock was above 50 (the strike price) then he would do better by just selling the shares in the open market, rather than exercise his put. Similarly for calls, if the stock finishes above the strike on expiration day then the buyer of the call option will exercise, and if the stock is below the strike he will not.
An options value in the market is made up of two parts: intrinsic value and time premium. The intrinsic value is the amount the option is "in the money". That is, for call options, if the stock is above the strike price, and for put options if the stock is below the strike price. Any additional value for the option would be ascribed to its "time premium" this is the about that will decay (reduce) as time passes, ending at zero on option expiration day. It is the source of income for investors who sell options.
People who buy call options are taking the risk that the underlying stock will rise above the strike price before the expiration date. If it does then they will be able to exercise their right and buy the stock at the strike price. Likewise, people who buy put options are taking the risk that the stock will fall below the strike price before the expiration date. This is sometimes called insurance because no matter how far the stock price falls the holder of the put will be able to sell his stock to the seller of the put for an amount equal to the strike price.
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