Call Options & Put Options
The two building blocks of using options as an avenue to trade the stock market are call options and put options. The concept of buying and selling calls puts must be properly grasped before anyone can move on to more advanced strategies such as bear call spreads, bull put spreads, condors and butterflies.
Buying a call gives someone the right, but not the obligation, to buy a stock at a specific price on or before a specific date. Buying a put gives someone the right, but not the obligation, to sell a stock at a specific price on or before a specific date.
Selling a call gives someone the obligation to sell the stock at a specific price on or before a specific date. Selling a put gives someone the obligation to buy the stock at a specific price on or before a specific date.
Many options traders adhere to a basic strategy by limiting their stock market involvement to buying calls and puts. Traders will buy a call when they expect the stock to increase in value and will buy a put when they expect the stock to decrease in value.
When buying a call option, the buyer wants the price of the underlying asset to increase in value. If that happens, the call will increase in value. To buy a call, a buyer pays a premium to obtain the right to exercise the option at the strike price. When the value of the underlying stock surpasses the strike price, the option is said to be in the money.
When selling a call option, the writer is paid a premium up front to begin the trade. The writer has the obligation to the sell the stock to the buyer at the strike price. If the buyer doesn't exercise the option because the stock doesn't move enough, the writer keeps the premium.
When buying a put option, the buyer wants the price of the underlying asset to decrease in value. If that happens, the put will increase in value. To buy a put, a buyer pays a premium to obtain the right to exercise the option at the strike price.
When selling a put option, the writer is paid a premium up front to open the trade. The writer accepts the obligation to buy the stock from the buyer at the strike price. If the buyer doesn't exercise the option because the stock doesn't move enough, the writer keeps the premium.
