Before we venture out into the trade of options, it remains critical to have a good understanding of the basics that are at the center of the options market. The two-leg structures which make up the skeleton of the option trading charges are the call option as well as the put option. When novice growers engage in these financial tools, they face a number of option trading costs that affect the profits earned, to some extent. Let’s in this blog find out more about call and put options so that you can can make good choices as a trader.
- Basics of Options Trading
Options trading is a general financial strategy through which the buyer and the seller can agree on later date price of a particular asset such as stocks, commodities or indices. Contrary to other financial instruments now familiar to investors where one can directly purchase or sell shares, options entail the right but not the requirement to engage in an actual trade of a certain asset at a particular rate within a specific period. Due to this reason, options trading is beneficial to both existing investors and the new traders because of its flexibility. However, to correlate such potential to options, one needs to first distinguish between call and put options.
- Speculation of the Up Markets
Call options are known as financial securities in which the purchaser acquires an option to buy a good at a specific price usually known as the strike price anytime before the contract expires. That is, particular call options can be employed by the trader for trading strategies that have the characteristic of price movements in the market as tend towards the higher side. This is probably why when you are a call holder, you assume that the price of the asset will rise above the strike price however before the call gets to expire. If indeed, you are right with your forecast, you can activate the option and buy the asset at a cheaper price to sell it in the market at a higher price for profit making.
- Profiting from Bearish Markets
On the same note, put options provide the option holder with an option to sell a certain underlying asset at an agreed price strike price before or by the expiration time. The put options are useful when the trader expect the market price of the underlining asset to drop. The purchaser of a put option is expecting that the price of the given asset will decrease to or below the strike price of the option before it expires. Your forecast to the price can be right in which case you can sell the asset at the higher strike price and purchase back the asset at the market price cheaper than the strike price and the difference is your profit.
- Key Differences Between Call and Put Options
There are differences between call as well as put option apart from the general meanings that have been explained above. One major difference is potential for profit where calls options increase in price as well as put options increase in falling prices. This fundamental difference defines them for different market conditions and trading strategies. The risk liability of each type also differs greatly in that HA risks are fundamentally more hazardous than those of HN or N. As with other options, the maximum loss on call options is the price paid for the option whereas the number of gains is theoretically inexhaustible. The maximum profit for put options is limited while the risk is relatively high for those who trade naked puts. There are also differences in the exercise plans and the former known as call option entitle the holder to buy the underlying assets while those who hold the put option has a right to sell the assets. All of the options expire as well as the rate of the time decay depends on in which position the options are – in-the-money, at-the-money, or out-of-the money options. Lastly, implied volatility as a factor impacts both as well as in general raises the premium of both styles; though its impact varies with the option’s moneyness.
- Strategies Involving Call and Put Options
Getting to know about call as well as put options helps a trader unleash a new string of trades. Covered call is a strategy where one invests in the underlying stock, sells call options on it to earn extra premium while at the same time may limit the stock’s potential gains Cap and collar are instances of this strategy. A protective put is utilised for maintaining long stock positions through the use of put options, therefore, creating an insurance layer. For those that predict a big change in price but are unsure such change will be up or down, they can use a straddle where one purchase both a call as well as put with the same strike price as well as expiration date. The other similar strategy to the straddle is the strangle where we employ different strike prices on the call option as well as the put option. Compared to the straddle it is generally cheaper but generates a profit only if the price difference is significantly larger. These strategies depict the double use of options and how it can be implemented depending on the outlook in the market as well as different risk levels.
Conclusion
To be able to make good decisions when trading options every trader must be adequately conversant with the difference between call and put options. Once you understand these basics it is possible for you to formulate better strategies and make sound decisions based on the outlook of your market as well as ability to handle risks. The more you advance to option trading level, other issues such as option trading brokerage fees should also be put into consideration concerning affectation of profitability. It is only with time and many experiences that one is in a better position to maximize on the strengths of option in the investment list.