When it comes to stock options there is often much confusion. Here is a look at the call and put option essentials.
When you purchase an option it means you have purchased either the right to buy or to sell shares of a specific security. You are not obligated to do so,
it is simply the option to do so that you have purchased. A call option, for example, gives you the right to buy the shares.
In the case of a call option, the option is not just to buy the security but to buy it at an already agreed upon price and before a certain date. The price that has been decided upon is referred to as the strike price.
The shares can be bought at any point before the expiration date in the U. S. If the call buyer decides to purchase, the call seller must let the shares go at the agreed upon strike price. A call buyer is said to exercise the option when he or she decides to purchase the shares.
In the case of a put option, the buyer is getting the right to sell a security at a predetermined strike price. As with the call option, there is an expiration date. If the holder of the put option decides to sell, the security shares must be bought at the agreed strike price.
When it comes to puts, the terminology can be a little confusing. The put buyer is actually the person selling the security. It is only the put that this person has purchased. Whether the option is a call or a put, the buyer of the option is described as having the long position.
Options are used by people hoping that share prices will rise or fall depending on the position they take. For example, with a call option, the buyer hopes that the share price will rise. Then, when they decide to purchase them at the lower strike price, a profit is made. The seller hopes that the share price will go down.
Put options work just the opposite. With a put option, the buyer hopes that the share price will go down. The writers in this case are hoping that the price will rise.
For the most part, shares do not actually change hands. The person who is engaged in a call option can then go make a put option. Options are often used as a method of managing a portfolio. When an option is purchased, a premium is paid for it.
European options differ from American ones. In European options, they can only be exercised on the date of expiration itself. In the case of American options, the buyer can exercise the right at any time up to the expiry date.
Many different models exist for determining option values, the most basic of which is the Black-Scholes one. A number of factors are considered in these models including the price of the security currently, the option strike price, the time until the expiry date along with any restrictions, the cost to hold a position and the estimated volatility of the security in question over the time of the option.
