- What is an Option? Put and Call Option Explained
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Updated Sep 18, What is a Stock Option? A stock option gives an investor the right, but not the obligation, to buy or sell a stock at an agreed upon price and date. There are two types of options: puts, which is a bet that a stock will fall, or callswhich is a bet that a stock will rise.
What is an Option? An option is a security, just like a stock or bond, and constitutes a binding contract with strictly defined terms and properties. For most casual investors, that definition may as well be written in ancient Greek. Put Options and Call Options Perhaps we can explain options a bit more clearly.
Key Takeaways Options give a trader the right to buy or sell a stock at an agreed-upon price and date. There are two types of options: Calls and Puts.
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One contract represents shares of the underlying stock. American options can be exercised at any time between the purchase and expiration date. European options, which are less common, can only be exercised on the expiration date.
Expiration Date Options do not only allow a trader to bet on a stock rising or falling but also enable the trader to choose a specific date when they expect the stock to options and the stock market or fall by.
This is known as the expiration date. Strike Price The strike price determines whether an option should be exercised.
It is the price that a trader expects the stock to be above or below by the expiration date. If a trader is betting that International Business Machine Corp. IBM will rise in the future, they might buy a call for a specific month and a particular strike price.
Stock Options Explained
Contracts Contracts represent the number of options a trader may be looking to buy. One contract is equal to shares of the underlying stock. Using the previous example, a trader decides to buy five call contracts.
Premium The premium is determined by taking the price of the call options and the stock market multiplying it by the number of contracts bought, then multiplying it by However, if a trader wanted to bet the stock would fall they would buy the puts.
Trading Options Options can also be sold depending on the strategy a trader is using.
Continuing with the example above, if a trader thinks IBM shares are poised to rise, they can buy the call, or they can also choose to sell or write the put. In this case, the seller of the put would not pay a premium, but would receive the premium.
Option Contract Specifications The following terms are specified in an option contract. Option Type The two types of stock options are puts and calls.