Call and Put financial options are contracts that grant the buyer the right, but not the obligation, to buy (Call) or sell (Put) an underlying asset at a given price (strike price) on or before a specific date (expiration date).
How do Call and Put options work?
Call Options
- Purchase: The buyer of a Call option has the right to purchase the underlying asset at the strike price on or before the expiration date.
- Profit: The benefit to the buyer of a Call option is limited to the rise in the price of the underlying asset above the strike price.
- Loss: The maximum loss to the buyer of a Call option is the premium price he paid for the option.
Put options
- Put: The buyer of a Put option has the right to sell the underlying asset at the strike price on or before the expiration date.
- Profit: The benefit to the buyer of a Put option is limited to the decline in the price of the underlying asset below the strike price.
- Loss: The maximum loss to the buyer of a Put option is the premium price he paid for the option.
What are Call and Put options used for?
Call and Put options can be used for a variety of purposes, including:
- Speculating on the price of an asset: Investors can buy Call options to speculate on a rise in the price of the asset or buy Put options to speculate on a fall in the price of the asset.
- Hedging a portfolio: Investors can buy Put options to protect themselves from a possible drop in the price of an asset they own.
- Generate income: Investors can sell Call or Put options to generate premium income.
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What are the risks of Call and Put options?
Call and Put options are complex financial instruments that carry a high risk. Some of the risks associated with Call and Put options are:
- Total loss of the investment: The buyer of a Call or Put option may lose the entire premium he paid for the option if the price of the underlying asset does not move in the expected direction.
- Volatility risk: Options are more sensitive to the volatility of the underlying asset price than the asset itself.
- Issuer risk: The purchaser of an option has risk that the writer of the option may not be able to meet its obligations.
How to choose the right Call and Put options?
When choosing Call or Put options, investors should consider:
- The price of the underlying asset: The price of the underlying asset is the most important factor determining the price of an option.
- The volatility of the underlying asset: The volatility of the underlying asset also affects the price of an option.
- The time to expiration date: The time to expiration date also affects the price of an option.
- The strike price: The strike price also affects the price of an option.
- Investor objectives: Investors should consider their objectives when choosing Call or Put options.
What are the types of Call and Put options?
There are different types of Call and Put options, including:
- American options: American options may be exercised at any time up to the expiration date.
- European Options: European options can only be exercised on the expiration date.
- Call/Put options on shares: Call/Put options on stock give the buyer the right to buy or sell shares of a company’s stock.
- Call/Put options on indexes: Call/Put options on indexes give the buyer the right to buy or sell a stock market index.
- Call/Put options on currencies: Call/Put options on currencies give the buyer the right to buy or sell a currency.
