Even if it’s your first time trading, you must know about the concept of options in derivative trading.
An ‘option’ is a contract that gives the trader the right to buy or sell off the underlying assets.
The trader can sell these assets at a specific price and with a certain expiration date.
So, the first thing to know about options is its two types – call options and put options. Read on, because this article will cover all the bases about the types of options.
What Is A Call Option?
A call option is an options contract that gives the call buyer a right to purchase a financial instrument within a specific time frame, at a specified price.
If the buyer wants to settle for a call option, they need to pay the option premium. The option premium is the price of the underlying asset. After purchase, it is at the discretion of the owner to exercise the options as they like.
You can let the call option expire if you think it is unprofitable. On the other hand, the seller has an obligation to sell the security the opposite party desires. The best part about a call option is that the losses are limited, and the profits know no bounds!
Example of A Call Option
You’ll be able to understand a call option better with the help of an example. Let’s consider that an investor buys a call option for stocks of company XYZ. The purchase date is specific, and the strike price is $2.
If the stock prices rise anywhere above $2, say $2.50 on the expiration day, the investor can still buy those stocks at $2. If you think that the stock price is going to rise, you can buy a call option. The call option will ensure significant marginal profits in the future.
Types Of Call Options
Call options are additionally classified into two types, they are;
- In the money: In this situation, the current price of the security is more than the strike price.
- Out of the money: There is another situation where the security’s current price is lower than the strike price.
- At the money: The security’s current price is equal to the strike price.
What Is A Put Option?
A put option gives the holder the right to sell the security within a specific period at the specified strike prices. In short, it lets the investor lock in a minimum price for security.
Like the call option, the put options do not bind the investor with an obligation for exercising the rights. If the current price is more than the strike prices, you can sell the securities at the current market price.
Example of A Put Option
We’ll also take an example of a put option to give you more insight. Let’s say an investor buys put options of company ABC. The purchase has terms that the investor can sell off the underlying assets anytime before the expiry period for $2.
In this period, if the share price falls below $2, say at $1.75, the trader can still sell it at $2. If the share prices surge, the investor can choose to hold it or exercise it as he wishes.
If the strike prices are plunging, the put option allows the holder to sell the securities at the strike price. As a result, it minimizes the risk for the holder.
Types Of Put Options
Just like the call option, there are also two types of put options, and here they are;
- In the money: You can consider the put option to be in the money when the current price is less than the strike price of the underlying.
- Out of the money: Your put option will be out of the money if the current market price is more than the strike price.
- At the money: The current market price is equal to the strike price.
The Bottom Line
To sum up, a trader might buy the call options if they expect the underlying asset price to rise shortly. On the other hand, the trader will purchase a put option if they expect the security rate to fall.
Both these types of options are heavily traded across all the exchanges in the world, in fact, the volume of options trades is far greater than that of equity.
Trading can be an intimidating affair, but only if you don’t know the basics. Now that you know all about the different derivative trading options, it’s time to invest!