March 3, 2009

Stock Options, Comparing The Two Types

The trade for stock options is fast on the rise in the market these days. With its many trading benefits and high promises for financial profit, many have become quite interested in buying and selling such contracts. Let us learn about the two types of these options in order to better understand how to trade them.

Knowing how each of these options would work to your benefit as the contract holder can surely come in handy with the volatile trends ongoing in the stock market.

The two major types of option contracts are the call option and the put option. Each of these contracts holds rights and benefits for their owners. Let us discuss each of these and how they can be useful to you.

Call Options

A call option is a type of contract that gives its owner the right to buy the underlying stock at a certain fixed price (also called the strike price) within a specified time frame, which should be on or before the expiry date. The buyer of a call holds the right to purchase shares at the strike price until the date of expiry. The writer or the seller of the call on the other hand, holds the obligation.

If a call buyer chooses to exercise his or her option by deciding to purchase the underlying share, then the call writer is then obliged to sell his or her share at the negotiated strike price.

For example, an investor purchases a call option from a certain company with a strike price of $10, which will expire in two months, then that buyer holds the right to exercise his or her option by paying the value of $10 for each share. The writer, on the other hand, would be obligated to give up the shares in the exchange for $10 for each of them.

Put Options

On the other hand, a put option is the total opposite of the previous. It is a contract that allows one to sell the underlying stock at a certain price on or before the expiry date. A put buyer holds the right to sell shares at the strike price, and following this, a put writer will then be obliged to sell at the negotiated price.

And so, if the investors who have purchased the stocks of a company would have growing concerns that business may not fair a current market slump, then they can buy a put option at a certain strike price in order to ensure the safety of their gains.

These investors would then hold the right, until expiry, to be able to sell their stock shares for the same amount they paid for them. Sellers of the put are then obligated to buy back the shares. If in the event that the company really did not do well during the market slump, then this could hurt on the part of the put seller.

Knowing about the differences between these two types of options are the first major step to guide you in making decisions in trading stock options. Be sure that you know what risks are involved in each type, so you would be able to know whether to buy a call or put option with the current behaviors of the stock market.