It’s easy to get overwhelmed with the idea of options trading, but once you understand the basics, things become more simple.
To start off, understand that an option is a contract that gives the buyer the right to buy or sell the underlying asset at a predetermined price on or before the expiration date. The buyer has no obligation to do so.
The buyer can buy the underlying asset in case of a call or sell the asset when owning a put. This is the primary difference between call and put.
Options are often used to hedge risk, earn an income, and speculate.
Easy, until now, right?
It’s time to get into the details of both, call and put options.
If you do not want to buy a stock, you can decide to buy a call option.
Owning a call will give you the right to buy the underlying asset on a predetermined date at the strike price. The cost of the call will be less than purchasing shares and you take part in any potential upside. That said, you’re under no obligation to make a purchase.
When you’re working with a call option, the potential loss narrows down to just the paid premium. The upside potential, on the other hand, is unlimited.
Here’s an example for a better understanding of the difference between a call and a put option.
Let’s say you were to buy the $150 strike call on May 8 in Company A; then you would have to pay about $3.40 (hypothetically). Now, if the stock were to trade above $153.40 on expiration, you would earn a profit.
If Company A were to close at $160 on the expiration date, you could exercise the call and purchase the stock at $150. The net price at this point would be $153.40, but with an immediate sale at $160, you would stand to make $6.60.
In simple terms, if you were to purchase a put option, you would get the right to sell the underlying asset at the strike price. The difference between call and put options is that the latter is mostly used to protect your long position if and when the price was to drop.
A put option can be used whether or not you own any underlying assets.
Let’s talk about Company A trading at $156.35, and one put option with the strike of 155 at the expiration date costs $4 per share. (Keep in mind, options trade in contracts which represent 100 shares of stock.) This means that you’d be paying $400 for one put.
Your long position in Company A will be protected until the end of the expiration date. A purchase would ensure a limited potential loss to $5.35 per share until expiry. ($4 + $1.35 = $5.35)
The difference between call and put options becomes clear at this point.
Furthermore, if Company A were to close at $150 on expiry, you could exercise the option. Meaning, you will exercise your right to sell at $155, and your loss will be limited to $5.35.
Call and put options are useful tools that can protect you from risks and increase the possibilities of earning a higher profit.
That said, if beginners are not careful, they could backfire. Only begin exercising call and put options after understanding how options contracts work.
So far, we’ve discussed buying options. Leverage and speculation are the most common reason to buy options. Selling options are a great way to reduce risk and boost income from a holding. OptionDash is a tool designed specifically to help investors screener for covered calls and cash secured puts.
Calls and puts will be impacted differently by the common influences on option prices.
Rho is a measure used to calculate the sensitivity of an option’s price due to a change in the interest rates. On the one hand, higher interest rates will increase the value of calls, while puts will decrease in value.
The value of an option will change drastically with a change in the strike. In the case of calls, the lower the strike, the higher their value. But as the strike increases, the value of call options decreases. This is where we see a difference between call and put, where puts that have a lower strike will be valued at less than puts that have a higher strike.
Delta is used to determine how changes in the underlying securities’ price will influence the option’s price. Delta for calls is positive, meaning their value increases as the stock price increase. And since puts have a negative delta, their value decreases when there’s a positive change in the underlying asset’s price.
If a stock’s ex-dividend is prior to an options expiration, it will impact the price of both the calls and puts, but differently. Upcoming dividend payments reduce call prices but increase put values.
Hopefully, you have a better understanding of put and calls at this point. Interested in trading your first covered call or cash secured put? Use optionDash to find your first options trade.Posted in Options and Options Trading |