A Call is a contract in the options market giving the right to the buyer to exercise it for buying the underlying commodity at the strike price on the expiry date or at any time up to that date. It is an option that is sold by a buyer to a seller for a specified quantity of a commodity or stock for a specific price but on a future date. The seller does not necessarily have to sell it to the buyer if there appears a buyer with a higher price on the future date, but if the seller insists the buyer will have to keep his promise, and this becomes exercising his call option. The option buyer thus has a right to buy, while the option seller gets the obligation which he will have to honor should the buyer exercise his right.
Put is the opposite of Call and it is an option contract giving the right to the holder to sell a specific quantity of a security or a commodity to the writer of the option at a strike price, or specified price, up to a specific date called the expiration date.
The Call option is purchased when the price of the underlying security is expected to rise before the expiration date of the option. This helps in making a profit without actually buying the security or commodity. On the other hand, in a reverse situation, when the price of a security is expected to fall before the expiry of the option, the person would use a put option.
Both call and put options are of two types each.
Thus there is a:
- Long call option-this involves buying a call option and is an offer of a leveraged alternative to a stock position. The more profitable the contract, higher leverage will increase the profits incurred. They are offers of a pre determined risk for all investors.
- Short call option-involves selling a call option which could be a call on shares or commodities owned (this is referred to as a covered call), or those that are not yet owned (referred to as naked call). The risks involved in each of these are different.
- Long put option – means buying a put option. This is perfect for those investors who wish to make money from a downward swing in prices of stocks or commodities. Long put option is meant for investors who have ample knowledge and experience and make precise decisions.
- Short put option-is about selling a put option when an investor is optimistic or bullish about price movements, or expecting them to rise. A short put option locks in the buying price of a stock at the strike price and the investor makes profits equivalent to the premium received.
Call and put options are used varyingly by investors in order to make money from the price trends of stocks, but are not risk free and therefore require experience, knowledge and extreme caution.
