Put Option

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In this options tutorial article, we'll discuss option puts and calls for dummies very basics of Option Contracts. That is, option puts and calls for dummies is an option?

Put simply, an option is a contract which you can buy from someone or sell to someone. Your responsibilities depend on whether you are the one buying or selling.

Now before getting into those responsibilities, lets talk about some important characteristics of an option contract and then we'll build option puts and calls for dummies on an example.

An option contract will always have an expiration date. An option contract will always have what's called a Strike Price. An option contract can be one of two types: Call or Put Lets talk about each bullet in more detail. I mentioned that an option is simply a contract, but a contract to do what?

It is a contract which gives the buyer the right to trade the underlying stock. One option contract is good for shares of that underlying stock.

The contract will also enforce a time frame to make that trade. An option will expire at the close of the third Friday of the stated expiration month. In addition, the contract will specify a strike price. This is referring to the price of the underlying stock not the option itself. Call vs Put But wait, there is something we're still missing. You may be asking yourself, well so what? That's where another very important characteristic comes into play and that is Call vs Put.

So which one do you choose? That depends on your personal belief on how IBM stock will behave. Remember that an option contract has an expiration date. In our example, it is May 15, Well then you want to buy a Put Option. To summarize, a Call Option gives you the right to buy low while a Put Option gives you the right to sell high.

Remember that buying the option contract gives you that right. Which means the person selling you the contract is actually giving you that right. In both scenarios you are buying low and selling high!

Now when I say you are buying and selling shares, it's not exactly correct. That's called an Option Assignment. And your brokerage firm will charge you a small fee for handling the nitty gritty transactions in the back end. Option Premium The one thing we didn't talk about so far is how much does it cost to buy an option contract? That depends on two factors. How close option puts and calls for dummies current market price is to the strike price and how much time is left before the option expires.

These two concepts are called Intrinsic Value and Time Value. A Call Option is said to have intrinsic value if the current market price is above the strike price. The rest of the option price is the Time Value. A quick side note about how option premiums are stated. When you see an option price quote, you will typically see the price divided by It's stated that way because one option controls shares.

Don't be confused or mislead and buy more options than you can handle! For a Put Option, obviously the Intrinsic Value would be based on how much lower the market price is relative to the strike price.

Time Decay An important factor to consider is the decay of time. The Intrinsic Value doesn't decay, just the Time Option puts and calls for dummies. Buying and Selling Options All this discussion was assuming the fact that you would keep the option contract until expiration.

But the fact is you may not want to. In reality many people do not buy and hold the option that long. If they see an increase in the option they bought they will most likely sell the option and take their profit. Now you know that as time proceeds the decay in Time Value will decrease the value of your option.

So the only way to make money is to hope that the underlying stock moves in your favour. But if IBM's market price increases as well, the decay in time value may be offset. You can probably guess by now that the closer the market price is to the strike price, the more the option is worth.

Now you can wait and see what happens on May 15th, but if you just wanted to take advantage of a short term price swing you can take your profits right now and run.

This section about reading options chains has been out dated, but it is still worthwhile to read through because you may still encounter these in various other websites. Click here to find out option puts and calls for dummies latest method of reading options chains.

Now that you know so much about options, lets talk about how to find them and how to interpret what you see. You can look at the diagram below or go directly to Yahoo by opening another browser page and entering the URL http: As you can see there is a table like the one below: The red circle indicates this is for May The first column shows all the available strike prices. The green circle shows a weird looking symbol. It's certainly not the symbol for IBM, but it looks similar.

There is a standard for listing option quotes which you can see by going to the cheat sheet see link on the right hand navigation. You can probably figure out the rest of the circles if you've seen stock quotes. A couple of things to point out is the pricing standard and the highted area. It is divided by and then listed. The volume however, has not been divided by anything! It really option puts and calls for dummies The final thing to note is the area highlighted in yellow.

Remember we talked about Intrinsic Value? The yellow highlighted options are referred to as "In the money" options. Buyer Beware Until now I've just been giving pure facts about options. Now I'm going to give some advice. You have to be very careful when trading options. People often tout the upside to options investing while playing down the risks involved. If you watch T.

While it is true that you can realize tremendous profits, the chances of you realizing tremendous losses are just as great. Even the best and brightest investment professionals cannot predict price movement especially over the short term. They get it wrong just as often as they get it right. At the end of the day, options are meant to add another dimension to your entire investment strategy, so be careful not to get wiped out as soon as you enter the option world.

It's option puts and calls for dummies to start out playing 5 to 10 options at a time. If you find you've made some money doing it, then you can risk more capital. New Options Chains As mentioned above, there is a new way to read options chains and it is quite easy to understand. You will see below: You can see it is almost self explanatory. The red circle represents the underlying stock symbol, the blue circle represents the expiration date, the option puts and calls for dummies circle represents the type option puts and calls for dummies option "C" for Call, "P" for Putand the black circle represents the the strike price.

The one small catch is that the expiration option puts and calls for dummies is stated as the day after the actual expiration date. I know weird, but the option actually expires as of close of market the day before. In the example above, the expiration date of '' readsMarch 22nd. That is, the option is already expired as of that morning.

But for your trading purposes you have to make sure that whatever trade you want to make has to get in before the close of market onMarch 21st. Summary Okay, we've gone option puts and calls for dummies a lot of material here. And you might still be confused. I suggest you read the material again or at least the parts where you got lost. Also from the menu above you can refer to a cheat sheet which lists all the important things you need to know about options without the long boring explanations and examples.

And don't forget to come back soon for any updates or new material I add to this site. Options for Dummies Learn how to trade options. Basic Options - What is an option? Designed by The entire content of this website is meant for educational purposes only.

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Call and put options are examples of stock derivatives - their value is derived from the value of the underlying stock. For example, a call option goes up in price when the price of the underlying stock rises. And you don't have to own the stock to profit from the price rise of the stock. A put option goes up in price when the price of the underlying stock goes down. As with a call option, you don't have to own the stock. But if you do, the put acts as a hedge - as the stock price goes down, the value of the put goes up so you are hedged against the downside.

You make money on options if your bet on the direction of price movement of the underlying stock is correct. If not, you'll probably loose most or all the money you paid for the option. Options are very sensitive to changes in the price of the underlying stocks.

Like gambling you can make or lose money very quickly. Because option prices change quite rapidly, owning them requires that you spend a significant amount of time monitoring price changes in the stock and the option. And if you're wrong about the price movement, be prepared to lose all or a significant portion of the money you paid for the options. A call is a contract that gives the owner the right, but not the obligation, to buy shares of a stock at a fixed price, called the strike price, on or before the options expiration date.

If the value of the stock goes down, the price of the option goes down, and you could hold it or sell it at a loss. The price that you pay for a call option depends on many factors two of which include: See the following videos: If you own a stock, you may buy a put as a form of insurance. If the stock falls in price, the put rises in price and helps offset the paper decline in the underlying stock.

If you don't own the stock but think it will go down in price, you buy the put to profit from the decline in price of the stock. If the stock price declines, the value of the put rises and you would sell the put for a profit. If the stock increases in price you may sell the put for a loss. A put option is a contract that gives you the right, but not the obligation, to sell a stock at a preset price.

The price that you pay for a put option depends the duration of the contract the longer the duration, the more you pay and how far the current price of the stock is from the strike price of the contract. Put buying is different from selling short. With a put option your only liability is the price you paid for the put. With a short sale, you have an unlimited downside liability if the stock goes up.

Also, the proceeds from selling short are in a margin account so you have to pay interest and meet margin requirements. Buying puts is a more conservative way of betting on a stock declining in price. Selling a Call For every buyer of a call there must be a seller, who assumes that the stock price will remain flat or go down. The seller collects the purchase price of the option but has the obligation to sell shares of the stock if the buyer decides to exercise the option.

If the seller gets called - he must sell the stock. If the stock continues to appreciate in price after the stock is sold, the seller looses the future price gain. In most cases you must own shares of the stock for each contract you sell - this is called a covered call. Therefore, if your stock gets called away, you have the shares in your account. You can sell covered calls to generate a stream of income.

If the stock price does not rise enough during the period of the contract, you won't get called and won't have to sell the stock so you keep the money you received when you sold the call. If your broker lets you, you may sell "uncovered "or "naked" calls in a margin account. This practice lets you sell calls when you don't own the stock. If you get called, you must buy the stock at its current market value to cover the call even when the market price is higher than the strike price of the option.

Like any margin account transaction, you must execute the transaction immediately. The seller of a put collects the purchase price of the option from the buyer of the put. The seller has the obligation to buy shares at the strike price regardless of the market value of the underlying stock.

So if the put buyer decides to exercise the put contract, the seller of the put has to buy the shares at the strike price no matter the current market value of the stock. When you sell a put, you want the price of the stock to go up so you don't get the stock put to you - buy the stock for more than it's worth.

Selling a put places the money you receive in a margin account so you pay interest on the proceeds until the put contract is closed.

If you don't have the financial resources to cover the obligation of buying the stock from the buyer of the put, you sold "naked puts". It tells about a trader who sold naked puts and experienced financial ruin. It was an unhedged bet, or what was called on Wall Street a "naked put" On October 27, , the market plummeted seven per cent, and Niederhoffer had to produce huge amounts of cash to back up all the options he'd sold at pre-crash strike prices.

He ran through a hundred and thirty million dollars - his cash reserves, his savings, his other stocks-and when his broker came and asked for still more he didn't have it. In a day, one of the most successful hedge funds in America was wiped out.

Niederhoffer was forced to shut down his firm. He had to mortgage his house. He had to borrow money from his children. He had to call Sotheby's and sell his prized silver collection Use calls and puts judiciously. If you're right, you can make quick money. If you're wrong, you can lose part or all of your investment very quickly. Do not sell "naked" options. You may be inviting a financial disaster.

Knowledgeable, experienced investors may want to sell covered calls and puts to collect other peoples money. Because the price of options can change very quickly and dramatically, you must continually watch their price movement. If you not prepared to do so, don't buy or sell options. Alternative Actions for the Call Buyer. Alternative Actions for the Put Buyer. Alternative Actions for the Call Seller. Alternative Actions for the Put Seller.

What the call buyer may do. Exercise call option if the stock price rises above the strike price. Buy shares at strike price, which is less than market price buy stock for less than it's worth.

Exercise option if the stock price declines. Sell shares at strike price, which is more than market price sell stock for more than it's worth. Put buyer must own shares to sell. Can already own them or buy them at market price, which is less than strike price. What the call seller may do. Sell shares at the strike price to the call buyer if the call buyer exercises the call option. If the call seller already has shares in his account, they are sold to the buyer at the strike price.

If the call seller does not have shares, he must buy the shares on the open market at a price greater than the strike price. What the put seller must do. Buy shares from the put buyer if the put buyer exercises the put option. If the put seller already has money in his account to buy the stock, the put option is covered. If the seller does not have money to buy the stock, the put option is naked. The put seller must come up with money to buy the stock.