Options Basics: Calls and Puts

Options are powerful financial instruments that can be used for speculation, income, or hedging. Understanding the basics is essential before considering any options strategies. [DEFINITION] Option: A contract giving the buyer the right (but not obligation) to buy or sell an underlying asset at a specific price (strike price) before a specific date (expiration date). ### The Two Types of Options **Call Options:** - Give you the right to BUY shares at the strike price - You profit when the stock goes UP - Like a "reservation" to buy at a set price **Put Options:** - Give you the right to SELL shares at the strike price - You profit when the stock goes DOWN - Like "insurance" against price declines [EXAMPLE] You buy a call option on Apple with a $180 strike price expiring in 30 days, paying $5 premium. If Apple rises to $200, your option is worth at least $20 (200 - 180), giving you a $15 profit per share. If Apple stays below $180, your option expires worthless, and you lose your $5 premium. ### Key Options Terms - **Premium:** The price you pay to buy an option - **Strike price:** The price at which you can buy/sell the stock - **Expiration:** The date when the option contract ends - **In the money (ITM):** Option has intrinsic value - **Out of the money (OTM):** Option has no intrinsic value - **At the money (ATM):** Strike price equals stock price [FORMULA] Call Profit = (Stock Price - Strike Price) - Premium Paid (if positive, otherwise max loss = premium) [KEY] Options have an expiration date. Unlike stocks, which you can hold forever, options have a ticking clock. Time decay (theta) works against option buyers every day. ### Why Use Options? **For Buyers:** - Leverage: Control 100 shares with less capital - Limited risk: Maximum loss is the premium paid - Speculation: Profit from directional moves **For Sellers:** - Income: Collect premium upfront - Probability: Many options expire worthless - Strategic entry: Sell puts to potentially buy stocks at lower prices [TIP] Most new options traders lose money because they don't understand time decay or implied volatility. Start by paper trading options before risking real money. [EXERCISE] A stock trades at $100. You buy a put option with a $95 strike for $2 premium. At expiration, the stock is at $90. What is your profit per share? |ANSWER| Put value at expiration = $95 - $90 = $5. Your profit = $5 - $2 premium = $3 per share. You profited from the stock's decline, even though you never owned the stock. [WARNING] Options can expire worthless, meaning you lose 100% of your investment. Never invest more in options than you can afford to lose completely. Options are complex and not suitable for beginners.