Options are financial derivatives that give the holder the right, but not the obligation, to buy or sell an underlying asset at a predetermined price within a specified period.

Call Options

Call Option: A call option gives the holder the right to buy the underlying asset at a specified price (the strike price) within a certain period (until the expiration date).

• Buyer of a Call: Pays a premium for the right to buy the asset. They benefit if the asset’s price rises above the strike price plus the premium paid.
• Seller (Writer) of a Call: Receives the premium and is obligated to sell the asset at the strike price if the buyer exercises the option.

Example: An investor buys a call option on a stock with a strike price of $50, expiring in three months, for a premium of $5. If the stock price rises to $60, the investor can exercise the option, buy the stock at $50, and potentially sell it at $60, making a profit (minus the premium paid).

Put Options

Put Option: A put option gives the holder the right to sell the underlying asset at a specified price (the strike price) within a certain period (until the expiration date).

• Buyer of a Put: Pays a premium for the right to sell the asset. They benefit if the asset’s price falls below the strike price minus the premium paid.
• Seller (Writer) of a Put: Receives the premium and is obligated to buy the asset at the strike price if the buyer exercises the option.

Example: An investor buys a put option on a stock with a strike price of $50, expiring in three months, for a premium of $5. If the stock price falls to $40, the investor can exercise the option, sell the stock at $50, and potentially repurchase it at $40, making a profit (minus the premium paid).

Key Terms

• Strike Price: The price at which the underlying asset can be bought (call) or sold (put) if the option is exercised.
• Expiration Date: The date on which the option expires. After this date, the option is no longer valid.
• Premium: The price paid by the buyer to the seller for the option.
• In-the-Money (ITM):
  • Call Option: When the underlying asset’s price is above the strike price.
  • Put Option: When the underlying asset’s price is below the strike price.
• Out-of-the-Money (OTM):
  • Call Option: When the underlying asset’s price is below the strike price.
  • Put Option: When the underlying asset’s price is above the strike price.
• At-the-Money (ATM): When the underlying asset’s price is equal to the strike price.

Strategies and Uses

• Hedging: Investors use options to protect against potential losses in their portfolio. For example, buying put options on a stock they own can protect against a decline in the stock’s price.
• Speculation: Traders use options to bet on the direction of an asset’s price movement. They might buy call options if they expect the price to rise or put options if they expect the price to fall.
• Income Generation: Investors can write (sell) options to generate income from the premiums received. For example, writing covered calls involves holding the underlying asset and selling call options to earn premiums.

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