Options 101: What’s The Difference Between Calls And Puts?
If you’re new to trading, you may have seen discussions in the world of options regarding call options and put options.
Often times, it’s taken for granted that the reader (or viewer) knows the difference between the two. But what’s the difference between them? How do they work? And how can you use them to your advantage?
So today, let’s go back to basics a bit and address these questions in a little bit of detail.
The most important thing to know is that every option represents a contract between a buyer and a seller.
When you buy a call option, you have the choice to buy the contract seller’s stock.
When you buy a put option, you have the choice to sell the contract seller your stock.
If you buy an options contract on a stock, you are paying money upfront to the options contract seller. This gives you the ability to either buy or sell that stock at the strike price on the expiration date.
Options are so named because the buyers get to choose whether they want to carry out the transaction. The buyers have the option of saying yes or no. So when an option expires, if it is not in the your best interest to buy or sell the stock at the strike price, then you aren’t obligated to do anything.
It’s a little different if you’re the one who sells that option contract. If the buyer chooses to exercise their option to buy or sell the stock, the seller must hold up their end of the deal.
In other words, an option gives us the ability to buy stock or sell a stock. It depends on what kind of option we purchase — a call option or a put option. Let’s look at both types of transactions in a little more detail.
A call option means you get to buy the contract seller’s stock.
Every option has a specific price and date attached to it. This is known as the “strike price” and “expiration date.” This type of option gives us (the option buyer) the choice to purchase 100 shares of the underlying stock at a specified strike price on the option’s expiration date. With call options, we are paying for the opportunity to buy the stock at the strike price. If we exercise this option, the option seller is required to sell us the 100 shares at the agreed-upon price.
For example, let’s say we want to buy a call option contract on shares of Intel (INTC). We choose an option with a strike price of $50 and an expiration date of May 20. Another trader sells you the call option contract. You immediately pay them a premium, which they get to keep no matter what.
When the calendar hits May 20, we can choose to buy 100 shares of INTC from the contract seller for $50 per share. And they would have to sell them to us. (If the price of the underlying stock is higher than the strike price, it is usually in your best interest to buy the stock from the seller.)
A put option means you get to sell your stock to the contract seller.
With put options, we (the option buyer) are paying for the opportunity to sell our stock at the agreed-upon price on the option’s expiration date. If we exercise this option, the option seller is required to buy the 100 shares from us at the strike price.
For example, let’s say we want to buy a put option contract on shares of Intel (INTC). We choose a contract with a strike price of $40 and an expiration date of May 20. Another trader sells you the put option contract and you immediately pay them a premium. They get to keep this no matter what.
When May 20 rolls around, we can choose to sell 100 shares of INTC to the trader who sold us the option contract for $40 per share. And they must buy them.
Bringing It All Together
Now you should understand the differences between calls and puts. And you’re one step closer to understanding how to use them to your advantage. But there is more you need to understand before you’re able to successfully trade options on a consistent basis. If you found this helpful, here are some other articles we’ve published that explain other important options-related terms:
There’s a reason why options make people a little nervous: They’re more complex than basic investments like stocks. But they are within reach of understanding for most investors, provided you are willing to learn. (And it goes without saying, you should never risk your hard-earned money on anything you don’t understand.)
Hopefully, this explanation helps you realize that the fundamental concepts behind options are not overly difficult to understand. And you certainly don’t need to be some kind of rocket scientist or financial whiz to learn how to use them.
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