Investing is risky since you never know what the market will do and when you’ll have to take small private loans to cover unsuccessful transactions. Investors may take advantage of this by purchasing and selling put and call options. These are contracts that offer the holder the right to buy or sell shares of stock at a predetermined price within a specific time period. Depending on whether you’re a buyer or seller — and how the market affects a stock’s price — each kind might result in profits or losses.
Here’s a deeper look at put and call options, what you should know about them, and how you might use them in your financial plan.
What Is the Purpose of a Call Option?
A call option is a contract that is linked to a certain stock. For the contract, you must pay a charge known as a premium. This provides you the right to purchase the stock at a predetermined price, known as the strike price, at any time until the contract expires.
You are not required to carry out the selection. If the stock price rises enough, you may execute the option or sell it for a profit. If it does not, you may let the contract lapse and lose just the premium you paid.
A call option’s breakeven point is the sum of the strike price and the premium. When you own a call option, you may determine your profit or loss at any time by subtracting the current price from the breakeven point. You may also use the calculator at the bottom of this page.
Call Option Benefits and Drawbacks
Benefits
- Purchasing put options in a turbulent market help protect against decreasing stock values;
- If market prices fall below the strike price, put options may provide a profit;
- Selling put options and charging a premium might produce cash.
Drawbacks
- You’ll have to pay a higher premium than you would for a call option;
- If the stock price remains the same or rises, you may lose the premium you paid;
- When selling put options, you run the chance of incurring substantial losses.
What Is the Purpose of a Put Option?
A put option is a contract that is linked to a certain stock. The contract costs a premium and gives you the right to sell the stock at the strike price. The contract may be executed at any time until its expiry date.
If the stock price falls enough, you may profitably sell your put option. You are not required to carry out the contract, so if the asset’s price does not fall enough, you may let the deal lapse.
The difference between the strike price and the premium is the put option’s breakeven point. When you own a put option, you may determine your profit or loss at any time by deducting the breakeven point from the current price or using the calculator at the bottom of this page.
To sell put options, you can work with an options trading platform or your brokerage to open an options account. You must first choose a reliable platform. You’ll then be able to submit a sell order for put options outlining the strike price, expiration date, and the underlying stock.
Put Option Benefits and Drawbacks
Benefits
- Purchasing a call option on a stock that increases in value before the expiry date might result in large winnings;
- A call option often has a smaller premium than a put option;
- You may profit by selling a call option and earning a premium for each share.
Drawbacks
- A call option has no value if the stock price remains at or falls below the strike price;
- If you do not exercise the option, you risk losing the money you paid as the option price;
- If a covered call option you sold is executed below the spot price, you risk losing shares of stock.
Price of a Strike
An option chain will offer several separate options, each with a different price, for each expiration date. These are distinguished by their varying strike prices: the price at which the underlying asset may be purchased or sold. A lower stock price costs more in a call option. A higher stock price costs more in a put option.
Profits
The buyer of call options seeks to benefit by purchasing equities for less than their growing value. The seller expects to benefit if stock prices fall or rise less than the amount paid by the buyer to create a call option. In this case, the buyer will not exercise their right to purchase, and the seller will be able to retain the paid premium.
The buyer of a put option expects that it will expire with the stock price above the strike price since the stock does not change hands and they benefit from the premium paid for the put option. If the stock price goes below the strike price, the sellers benefit.
Risks
When compared to purchasing the underlying securities, options are high-risk and high reward. When options expire, they are completely useless. Furthermore, if the price does not move in the desired direction, the investor wins nothing by exercising the options.Â
When purchasing stocks, the danger of losing the full investment amount is typically relatively modest. Options, on the other hand, provide extremely significant rewards if the price moves dramatically in the investor’s desired direction.
Which Is Better: A Call Option or a Put Option?
It depends on which side of the transaction you’re on and your expectations about future price movement whether you want to employ a call option or a put option.
When purchasing options, you should purchase a call if you believe prices will increase and a put if you believe prices will fall. This allows you to acquire shares at a lower price or sell them at a higher price.
When selling options, sell calls if you anticipate prices to fall and puts if you expect prices to climb. This allows you to keep the premium without fear of the buyer breaching the contract.
Conclusion
Options are derivatives that allow you to purchase or sell the right to buy or sell equities at a predetermined price. While purchasing options carry a low risk, selling them carries a high, possibly unlimited risk. Remember this while deciding whether to purchase or sell options and what sort of options to utilize in your investment plan. Also, keep in mind that trading derivatives are riskier than trading equities.
