February 18, 2009
Put and Call Options Basics
By Planet Wealth
If you buy a Call option over a stock, it means you have the right (but not the obligation) to BUY the actual stock at an agreed price on or before an agreed date.
If you buy a Place option over a stock, it means you have the right (but not the obligation) to SELL the actual stock at an agreed price on or before an agreed date.
The thought behind buying options, rather than buying actual stock in the underlying company, is you can essentially ‘control’ the stock while only laying out a fraction of the cost.
It’s a simple case of Control versus Ownership. We can get all the benefits and profits from controlling the stock, without needing to place up large r) amounts of money to buy it in the first place.
Let’s go over an example…
A company has a stock price of $30, and if you wanted to buy that stock, you’d need to outlay $30 for every stock. Or you can buy an option that gives you control over that stock for a fraction of the price, often less than 5%. That means you can have control of the stock for only $1.50 (as an example), instead of laying out the full $30.
This is known in financial circles as ‘leverage’, and getting this leverage is the reason options are used, instead of simply buying the stock outright.
Let’s have a brief look at the benefits and risks in using options, so you know why professional traders use options. We’ll compare a trade using the actual stock to one using stock options.
In the first example, the stock is $30, and we’ll assume the stock goes UP by $3 to $33. If you bought the stock at $30, and we’ll assume the stock goes UP by $3 to $33. If you bought the stock at $30, you have made a 10% return on your money.
Topics: call options, options trading, put options | No Comments »
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