Oliver James Montgomery Explains the Basics of Call and Put Options
What Are Options? A Beginner's Guide to Financial Power
Options are financial instruments that give investors the right, but not the obligation, to buy or sell a specific stock at a predetermined price within a set period. They provide a unique form of leverage, allowing traders to control a larger amount of stock with a smaller investment.
Types of Options: Call and Put Options
In the U.S. stock market, there are two main types of options: call options and put options.
Call Option: The right to buy the underlying stock at a specified price.
Put Option: The right to sell the underlying stock at a specified price.
Traders can take four possible actions with options:
Buying a Call Option (Long Call): You purchase the right to buy the stock at the strike price.
Selling a Call Option (Short Call): You sell someone else the right to buy the stock at the strike price.
Buying a Put Option (Long Put): You purchase the right to sell the stock at the strike price.
Selling a Put Option (Short Put): You sell someone else the right to sell the stock at the strike price.
Shorting Options: How It Works
When you "short" an option, you are selling it without owning it, similar to shorting stocks. If you sell a call or put option, you are obligated to fulfill the terms of the option contract if the holder exercises it.
Shorting a Call Option: If the option holder exercises the call, you must sell them the stock at the strike price. If you don't already own the stock, you'll need to buy it at the current market price and sell it at the strike price.
Shorting a Put Option: If the option holder exercises the put, you must buy the stock at the strike price. You need to ensure you have enough margin in your account to purchase the stock; otherwise, you could face a forced liquidation.
Key Concepts in Options Trading
Expiration Date: The last date the option can be exercised. After this date, the option expires worthless.
Strike Price: The price at which the option holder can buy or sell the underlying stock.
Premium: The price paid to purchase the option. The premium fluctuates based on factors like time to expiration and the volatility of the underlying stock.
Options can be a powerful tool for hedging, speculation, or generating income, but they also come with risks due to their time-sensitive nature and potential for significant losses, especially when shorting options. Understanding these concepts is essential for anyone looking to enter the options market.