Puts, calls, strike prices, premiums: The jargon may be confusing, but here’s how to make sense of options trading.
To understand what options are, it helps to compare them with stocks. Buying stock means you own a tiny portion of that company, called a share. You’re anticipating the company will grow and make money in the future, and that its share price will rise. If this happens, you can sell the shares for a profit.
An option, on the other hand, is just a contract that gives you the right to buy or sell a stock or other underlying security — usually in bundles of 100 — at a pre-negotiated price by a certain date. However, when that date arrives, you’re not obligated to buy or sell the stock. You have the option to let the contract expire, hence the name.
It’s important to note that options exist for all kinds of securities, but this article looks at options in the context of stocks. There are two main types of options contracts:
Call options. A call option gives you the right to buy a company’s stock for a specific price (known as the “strike price”) within a specific time period, referred to as its “expiration.”
We use options for different reasons, but the main are
Buying an option means taking control of more shares than if you bought the stock outright with the same amount of money.
Options are a form of leverage, offering magnified returns.
An option gives an investor time to see how things play out.
An option protects investors from downside risk by locking in the price without the obligation to buy.
