Call and Put Options

Call and Put Options

Call and put options are a type of financial instrument that allows investors to buy or sell a stock at a fixed price at a future date.

A few high level points

• Call options give the buyer the right to buy a stock at a fixed price at a future date.
• Put options give the buyer the right to sell a stock at a fixed price at a future date.
• The fixed price is called the strike price.
• The future date is called the expiration date.
• You want to buy a call option if you think the stock will go up (bullish).
• You want to buy a put option if you think the stock will go down (bearish).
• As a buyer, you pay a premium to the seller for the right to buy or sell the stock.
• As a seller, you receive the premium for the right to sell or buy the stock.
• As a buyer, you can exercise your option at any time before the expiration date.
• As a seller, you are obligated to buy or sell the stock at the strike price on the expiration date.
• As a buyer, you cannot lose more than the premium you paid for the option.
• As a seller, you can lose virtually unlimited amount of money.

Example

Let’s say you buy a call option for 100 shares of X at a strike price of $100.

• The premium is $10 per share.
• You pay $1000 for the option.
• If the stock price is $100 or less at the expiration date, you lose the premium you paid for the option.
• If the stock price is $110 at the expiration date, you are break even as you paid $10 per share and the stock is now $110.
• If the stock price is $120 at the expiration date, you make a profit of $10 per share.

As the seller, you receive the premium and are obligated to buy or sell the stock at the strike price on the expiration date.

• If the stock price is $100 or less at the expiration date, you make a profit of the premium you received for the option.
• If the stock price is $110 at the expiration date, you are break even as you received $10 per share and the stock is now $110.
• If the stock price is $120 at the expiration date, you lose $10 per share.

Now, let’s say you buy a put option for 100 shares of X at a strike price of $100.

• The premium is $10 per share.
• You pay $1000 for the option.
• If the stock price is $100 or more at the expiration date, you lose the premium you paid for the option.
• If the stock price is $90 at the expiration date, you are break even as you paid $10 per share and the stock is now $90.
• If the stock price is $80 at the expiration date, you make a profit of $10 per share.

As the seller, you receive the premium and are obligated to buy or sell the stock at the strike price on the expiration date.

• If the stock price is $100 or more at the expiration date, you make a profit of the premium you received for the option.
• If the stock price is $90 at the expiration date, you are break even as you received $10 per share and the stock is now $90.
• If the stock price is $80 at the expiration date, you lose $10 per share.

Call spread

A call spread is a strategy that involves buying a call option and selling a call option with a higher strike price.

• You buy a call option with a strike price of $100.
• You sell a call option with a strike price of $110.
• You pay $10 for the call option with the lower strike price.
• You receive $10 for the call option with the higher strike price.

Put spread

A put spread is a strategy that involves buying a put option and selling a put option with a lower strike price.

• You buy a put option with a strike price of $100.
• You sell a put option with a strike price of $90.

References

• Call and Put Options Explained