What exactly are Options?
In the world of trading, options are exactly what their name implies. They represent a right to buy or sell shares of a certain stock.
As in any trade, options require two parties. Someone needs to sell the shares and someone needs to buy the shares.
Sometimes, selling is referred to as writing. The company associated with the underlying stock is not involved in the transaction at all. Ultimately, trade options occur when one party purchases the option to either buy or sell stock shares at an agreed upon price by a certain expiration date.
Call Option and Put Option
A call option places choice on the buyer and obligation on the seller. Someone might buy the right to purchase shares in Company A for $22 each for the next two months. No matter what the market does, the seller is obligated to sell those shares at that price if the buyer exercises his or her option.
A put option occurs when someone buys the right to sell shares at a certain price. If that person decides to exercise the option to sell, then the buyer is obligated to buy at the contract price.
Why Buy Options?
Options are an investment entered into by traders who think they have a better understanding of the market than someone else. For example, in a call option, the buyer believes there is a chance that the share price will increase before expiration date, so he or she locks in the chance to purchase at the current price. Obviously, the seller agrees to this option because he or she believes the stock will remain consistent or devalue before expiration date.
Options can be combined into strategies that expose the trader to less risk. Some common trading strategies include vertical spread, butterfly spread, and debit spread. In a vertical spread, a trader options to buy stock at a certain price and to sell stock based on the same security at a different price. If the stock currently trades at $10 and the trader has 100 shares, he might option to sell those shares for $10. He might also option to buy shares from someone else for $8. If both options go through, regardless of share price at the time, he has made a profit.
Most experts recommend that beginners become educated before getting involved with options. Although trades can be constructed where there is a very good chance of profit, there can also be a high risk associated with options trading especially for someone who doesn’t understand what they are doing.
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