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The Beginner’s Guide to Options Trading: Calls and Puts Explained

February 27, 2015

One of the most misunderstood and complicated trading techniques is known as options trading. Many experienced investors avoid the field, largely because they simply cannot wrap their heads around it. A lot of stockbrokers take the same approach, and this is enough to scare the majority of traders aware. For the erstwhile, however, and those who relish a challenge, options trading can prove incredibly rewarding and extremely profitable, as well as making a fantastic hedging strategy. More information on options trading can be found at www.sucdenfinancial.com.

If you’re intrigued, read on if you dare.

What is Options Trading?

Essentially, an options contract is simply an agreement that gives its possessor the right to buy or sell a specific stock at a future date.

The buyer or holder is always called long. Their capital buys them the right to buy a stock from, or sell a stock to, the seller of the contract at a future time.

The seller or writer is always called short.

The owner is not obligated to execute the contract by buying or selling the stock before the expiration date.

Understanding Calls and Puts

A standard options contact tends to be for 100 shares of stock, and has nine months before it expires. Two types of options contracts exist: calls and puts.

If you’re a buyer, you purchase a call option. This means that you buy the right to obtain a stock at any point within the contract timeframe at a pre-agreed price.

If your position is a long call (which means that you buy calls), then you believe that the stocks price will rise. Those selling puts believe the same. Conversely, long puts and short calls believe that a stock will decrease in value.

Buyers will only execute the contract if they believe they can make a profit on it. Many of the investors who sell options do not believe that they’ll ever actually be executed. However, this matters little to them, as the sale alone brings in a premium.

Examples

One of the best ways to gain an understanding of options trading is to look at some examples of how call and put contracts work.

Firstly, imagine that you purchase a call option on ABC. This contract expires on 1st March. The shares are priced at $100 each and there is a $2 premium on them. If you buy the option, this means that you have the choice to purchase this stock at $100 per share at any time between the date of sale and the 1st March, irrespective of their real price at the time. In return, you would pay the writer $200 (100 shares x $2 premium per share) for the option. The seller could keep this money even if you chose not to redeem your contract.

A put order would work in a similar manner. If, this time, you had the option to sell 100 shares in ABC at $100 per share before 1st March, with a put of 2, you would pay $200 to the writer to do so. This would mean that if the real price fell, you could sell your shares for quite a bit more than they were actually worth.

Now that you understand it a little better, could options trading be the perfect match for you?