What are Options: Calls and Puts?
Investing in options can be a complex yet potentially very rewarding endeavor. For those who are engaged in options trading, it is essential to have a deep understanding of the two primary types of options: calls and puts. These form the bedrock of the trading process.
In this article, we will take a closer look at options trading, clarify the roles of calls and puts, examine their mechanics, and discuss the benefits and potential pitfalls they present.
What are call and put options?
Call and put options are financial derivatives that provide investors with flexibility and strategic opportunities in the capital markets. They are contracts that give the buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price, known as the strike price, before a specified expiration date.
Call Options:
A call option lets you buy a stock at a set price before a certain date. You buy it if you think the stock will go up. If it does, you can buy it at the set price and sell it for more, making a profit. If not, the option is worthless, and you only lose what you paid for the option.
Selling a call option means you get paid (premium) to maybe sell a stock later. You keep the premium if the stock price stays the same or goes down. But if the stock price goes up, you might have to sell it at the set price, which could be a loss if the market price is much higher.
Put Options:
A put option lets you sell a stock at a set price before a certain date. You buy it if you think the stock will go down. If it does, you can sell it at the set price and profit from the drop. If not, the option is worthless, and you only lose what you paid for the option.
Selling a put option means you get paid (premium) to maybe buy a stock later. You keep the premium if the stock price stays the same or goes up. But if the stock price goes down, you might have to buy it at the set price, which could be a loss if the market price is much lower.
Examples of call and put options
To better understand the practical application of call and put options, let's explore some hypothetical examples that illustrate how these financial instruments work in real-world scenarios.
Examples of Call Options:
Bullish Market Outlook:
Scenario: You believe that the stock of Company ABC, currently trading at $50 per share, will increase in value over the next three months.
Action: You buy a call option with a strike price of $55, expiring in three months, for a premium of $2 per share.
Possible Scenarios: If the stock price rises to $60 before expiration, you can exercise the option to buy the stock at $55, making a profit of $3 per share ($60 - $55 strike price - $2 premium). If the stock price remains below $55, you might let the option expire, limiting your loss to the premium paid.
Covered Call Writing:
Scenario: You own 100 shares of Company XYZ, and you're willing to sell them at a price above the current market value.
Action: You sell a call option with a strike price of $60, expiring in one month, for a premium of $3 per share.
Possible Scenarios: If the stock price stays below $60, you keep the premium and maintain your shares. If the stock price rises above $60, you may be obligated to sell your shares at $60, but you still benefit from the premium received.
Examples of Put Options:
Bearish Market Outlook:
Scenario: You think the stock of Company DEF, currently at $40 per share, will decrease in value over the next two months.
Action: You buy a put option with a strike price of $35, expiring in two months, for a premium of $1.50 per share.
Possible Scenarios: If the stock price falls to $30 before expiration, you can exercise the option to sell the stock at $35, making a profit of $3.50 per share ($35 strike price - $1.50 premium - $30 market price). If the stock price remains above $35, you might let the option expire, limiting your loss to the premium paid.
Cash-Secured Put Writing:
Scenario: You're considering buying shares of Company GHI, currently at $25 per share, but you want to buy them at a lower price.
Action: You sell a put option with a strike price of $20, expiring in one month, for a premium of $1 per share.
Possible Scenarios: If the stock price stays above $20, you keep the premium. If the stock price falls below $20, you may be obligated to buy the shares at $20, but you still benefit from the premium received, effectively lowering your cost basis.
How do call options work?
Definition: A call option gives the buyer the right, but not the obligation, to purchase an underlying asset at a specified price (the strike price) within a certain time frame (until the expiration date).
Purchase Motivation: Investors opt to purchase call options with the anticipation that the value of the underlying asset will exceed the strike price prior to the option's expiration.
Premium Payment: When you buy a call option, you pay a premium to the seller of the option. This is the maximum amount you can lose if the option is not exercised.
Exercise or Not: If the market price of the asset exceeds the strike price plus the premium paid, it may be financially advantageous to exercise the option. Otherwise, you might let the option expire, resulting in a loss of the premium.
Profit Potential: If the asset's market price rises significantly above the strike price, the buyer can exercise the option and buy the asset at the lower strike price, then sell it at the higher market price, pocketing the difference minus the premium paid.
Seller's Obligation: The seller (or writer) of the call option has the obligation to sell the underlying asset at the strike price if the buyer decides to exercise the option.
How do put options work?
Definition: A put option gives the buyer the right, but not the obligation, to sell an underlying asset at a specified price (the strike price) within a certain timeframe (until the expiration date).
Purchase Motivation: Investors buy put options when they anticipate the price of the underlying asset will fall below the strike price before the option expires.
Premium Payment: When you buy a put option, you pay a premium to the seller of the option. This is the maximum amount you can lose if the option is not exercised.
Exercise or Not: If the market price of the asset drops below the strike price minus the premium paid, it may be financially advantageous to exercise the option. Otherwise, you might let the option expire, resulting in a loss of the premium.
Profit Potential: If the asset's market price falls significantly below the strike price, the buyer can exercise the option and sell the asset at the higher strike price, then buy it back at the lower market price, pocketing the difference minus the premium paid.
Seller's Obligation: The seller (or writer) of the put option has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise the option.
Two types of call options
Call options can be utilised in various ways, each offering different strategies and risk profiles. The two main types of call options strategies are long call options and short call options. Let's delve into each type and understand their workings.
Long Call Options
Long call options are the most straightforward call option strategies. A speculator acquires a call option with the expectation that the value of the underlying security will surpass its strike price prior to the expiration date.
How Long Call Options Work:
Purchase: An investor secures a call option by paying a fee to the seller, thereby obtaining the privilege to purchase the underlying asset at the predetermined strike price.
Hold or Sell: If the value of the underlying asset surpasses the sum of the strike price and the premium paid, the option turns profitable. At this point, the investor has the option to either execute the option to purchase the asset at the strike price and subsequently sell it at the elevated market value, or to offload the option contract for a higher premium before expiration.
Expiration: If the asset's price does not rise above the breakeven point, the investor can choose not to exercise the option, and the maximum loss is limited to the premium paid.
Example: Suppose an investor buys a call option with a strike price of $100 and pays a premium of $5 per share. The breakeven point is $105. If the stock price rises to $120, the investor can exercise the option and make a profit of $15 per share, minus the premium, resulting in a net profit of $10 per share.
Short Call Options
Short call options involve selling a call option, giving the buyer the right to require the seller (the one who wrote the option) to sell the underlying asset at the strike price.
How Short Call Options Work:
Sale: The investor sells a call option, receiving a premium from the buyer for taking on the obligation to sell the underlying asset at the strike price if the option is exercised.
Obligation: If the buyer exercises the option, the seller must sell the underlying asset at the strike price, even if the market price is higher. This can result in a significant loss if the asset's price has risen substantially.
Profit and Loss: The maximum profit for the seller of a call option is the premium received, as the potential loss is theoretically unlimited if the asset's price increases indefinitely.
Example: An investor sells a call option with a strike price of $50 and receives a premium of $3 per share. If the stock price remains below $50, the option will likely expire worthless, and the investor keeps the premium. However, if the stock price rises to $60, the investor must sell the stock at $50, resulting in a loss of $7 per share, minus the premium received, resulting in a net loss of $4 per share.
In conclusion, long call options offer a limited risk strategy with unlimited profit potential, making them attractive for bullish market outlooks. Short call options, on the other hand, can generate income through premiums but come with the risk of significant losses if the market moves against the investor. Understanding these two types of call options is crucial for investors looking to incorporate options into their trading strategies.
How to trade options in moomoo?
Moomoo provides a user-friendly platform for options trading, catering to both novice and seasoned traders. To embark on options trading with Moomoo, follow these streamlined steps:
Account Setup: Initiate the process by creating a brokerage account with Moomoo. This can be accomplished via their website or by installing the Moomoo app on your iOS or Android device. Complete the registration by submitting the necessary personal information.
Account Funding: Ensure your Moomoo account is adequately funded to cover the costs of your initial options trades.
Navigating the Options Chain: Options serve as versatile tools for risk management, investment enhancement, and profit maximisation. To identify suitable options for a specific stock, utilise Moomoo's Options Chain tool:
Access the "Detailed Quotes" for your chosen stock.
Navigate to "Options" and select "Chain" from the menu.
The interface will display options for the nearest expiration date by default. Filter the view to show only calls or puts by selecting the appropriate filter.
Adjust the expiration date as needed by choosing a different one from the options provided.
Options that are out-of-the-money are presented in white, while those that are in-the-money are highlighted in blue for easy identification. Scroll horizontally to reveal more details about each option.
Placing an Order: After selecting an option contract that aligns with your strategy, you can proceed to place your trade. Use the bottom of the screen to toggle between different trading strategies. Thoroughly review your order to ensure all details are accurate before finalising the transaction.
Trade Management: Post-trade, maintain close surveillance of your positions and market movements. Moomoo equips you with real-time market data and notifications to stay updated. Employ the platform's features to manage your trades effectively, including the setting of stop-loss orders to guard against excessive losses.
What is the strategy of call and put options?
Call and put options are versatile financial instruments that can be employed in a multitude of strategies to achieve various investment goals, including speculation, hedging, and income generation. Understanding these strategies is crucial for investors looking to leverage options effectively.
Single Option
The single option strategy is a fundamental approach to options trading, involving the purchase or sale of a single options contract, whether it's a call or a put, based on the investor's outlook for the underlying asset. Put options, in particular, offer the investor the right to sell a stock at a set price, serving as a safeguard against potential losses if the stock's value declines.depending on the investor’s view of the underlying asset. Put options, in particular, grant the investor the right to sell a stock at a predetermined price, providing a protective measure against downside risk.
Covered Stock
The Covered Call strategy involves holding a stock while also selling call options on an equal number of shares. This means selling call options for stocks you already own, creating a "covered" position that can generate additional income from the premiums received.
Vertical Spread
A Vertical Spread involves buying and selling two options with the same expiration date but different strike prices at the same time. This can be a bullish or bearish strategy. A common example is the put spread, which includes strategies such as the bull put spread and the bear put spread.
Straddle
The Straddle strategy is designed to profit from significant price movements in the stock, irrespective of the direction. It involves buying both call and put options on the same underlying asset with the same expiration date and strike price, allowing the investor to benefit from a large move in either direction.
Strangle
The Strangle strategy allows investors to speculate on substantial market price changes at a lower cost. Unlike the Straddle, the Strangle is set up with options at different strike prices, which reduces the upfront cost. However, it requires a larger price movement to become profitable due to the wider range between the strike prices of the options involved.
In conclusion, the strategies of call and put options are diverse and can be tailored to fit various market outlooks and risk profiles. Whether an investor is looking to speculate on price movements, hedge existing positions, or generate income, options provide a flexible and powerful set of tools to achieve these objectives.
Risks and opportunities of call and put options
Risks of Call and Put Options:
Premium Loss: Buyers risk losing the entire premium if the market moves against them.
Unlimited Loss Potential: Naked call writers face theoretically unlimited losses if the underlying asset's price rises significantly.
Assignment Risk: Sellers can be assigned at unfavourable prices, leading to substantial losses, especially in volatile markets.
Expiration Decay: Options lose value over time, risking a total loss if the expected price movement doesn't occur before expiration.
Opportunities of Call and Put Options:
Hedging: Investors can use put options to protect their portfolios from downside risk.
Speculation: Traders can speculate on price movements by buying calls or selling puts for anticipated rises, or selling calls or buying puts for anticipated declines.
Income Generation: Sellers can generate income by collecting premiums from buyers.
Options trading offers a range of strategies for different market approaches. It's a tool for hedging, income, or market speculation. But, it's important to trade with a plan, as it comes with risks.
