Options Definition
An ‘Option’ is a type of security
that can be bought or sold at a specified price within a specified period of
time, in exchange for a non-refundable upfront premium. An options contract
offers the buyer the right to buy, not the obligation to buy at the specified
price or date.
Types Of Options
Call and Put are two types of Options.
1. Call - A call gives the holder
the right to buy an asset at a certain price within a specific period of time.
Calls are similar to having a long position on a
stock. Buyers of calls hope that the stock will increase substantially before
the option expires.
2. Put - A put gives the holder the right to sell an asset at a certain price within a specific period of time. Puts are very similar to having a short position on a stock. Buyers of puts hope that the price of the stock will fall before the option expires.
Example of Call and Put Options
1. Suppose the stock of XYZ company is trading at $40. A call option contract with a strike price of $40 expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will rise sharply in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ call option covering 100 shares.
2. Suppose the stock of XYZ company is trading at $40. A put option contract with a strike price of $40 expiring in a month's time is being priced at $2. You strongly believe that XYZ stock will drop sharply in the coming weeks after their earnings report. So you paid $200 to purchase a single $40 XYZ put option covering 100 shares.
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