Options
A contract giving an investor a right to buy (call) or sell (put) a fixed amount of shares (usually 100 shares) of a given stock (or indexes and commodities) at a specified price within a limited time period (usually three, six, or nine months). The purchaser hopes that the stock’s price will go up (if he bought a call) or down (if he bought a put) by an amount sufficient to provide a profit when he sells the option. If the stock price holds steady or moves in the opposite direction, the price paid for the option is lost entirely. Individuals may write (sell) as well as purchase options. A buyer of a call option, for the right to buy 100 shares of the underlying security at a fixed (strike) price before a specified future date (expiration), pays the call option writer a fee called a premium. If the option is not exercised before it expires, the premium paid is lost. Thus, a call buyer believes that the price of the underlying shares will rise before the option expires. If the call buyer does exercise the option, the shares are bought from the writer at the option’s strike price. The amount due to the writer equals the strike price multiplied by the number of shares. A buyer of a call option is generally bullish about the security, or in the case of index options, the market. A writer of a call option usually believes the security or the market will not move substantially up–thus, not making it worthwhile for the buyer to exercise. A buyer of a put option, for the right to sell 100 shares of the underlying security at a fixed price before a specified future date, also pays a premium to the writer of the put. A put buyer believes that the price of the underlying security is going to decline. If the put buyer exercises the option, the underlying security shares are sold to the put writer at the option’s strike price. A put buyer is generally bearish about the security or the overall market. The writer typically believes the security or the overall market will not move substantially down–thus, not making it worthwhile for the buyer to exercise. Buyers of options do not have to exercise an option in order to profit–they may attempt to profit on the option by selling it before its expiration by trading on the rise and fall of premium prices. Writers may also attempt to profit by buying back the option sold at a lower price (or it can expire worthless). An option seller can either write uncovered (interchangeably called “naked”) or covered options. Naked options are far riskier.
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