What are the options? How do options work?

If you think trading options "dangerous" it is understandable.

Yet, is this the truth indeed?

As you learn more about this investment product, we think your mindset will change. Since options to mitigate risks are also used.

With the aid of choices, you too can restrict your risks. Simple knowledge about this product, however, is important.

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What are the options, and how do they work exactly?

You can understand the most significant terms after reading this post, understand the difference between call and put options, and what 'going long' and 'going short' means.

Themes addressed in this article:

 

1. Relevant Words
2. Options to call and options to position
3. The Long & Short

 

A. Words important:

 

What are the options?

 

A choice is a derivative that offers the buyer the right at a fixed price at a given time to sell or purchase a specific good. The value of an option depends mainly on the price of the underlying asset, the duration of the options contract, and the volatility.

 

What is a call option?

A call option is a financial product that gives the buyer the right to purchase an underlying asset at a pre-defined price, such as a share ( exercise price ). Also, the date (the so-called expiry date) on or up to which the right can be exercised is specified. The price the option is traded for is referred to as the option premium.

What's the Put Option?

 

A put option is a financial product that gives the buyer the right, at a predetermined price, to sell an underlying asset, such as a share. Also mentioned is the date on which the right may be exercised or until (expiry date). The amount at which the option is being exchanged is called the premium of the option.

 

What is the option's underlying value?

The financial commodity on which the price of a derivative is based on the underlying asset. (e.g. a particular share, index, currency, or specific commodity). Options, futures, and leverage products are well-known examples of derivatives with an underlying asset.

What is the date of an option expiration?

 

The expiry date shows when a financial product expires, such as an option or a future. The default expiration date is the third Friday of the expiration month. However, there are also different closing dates for German and American options markets, such as for regular options and weekly options.

 

What is the option's strike price?

 

An option's strike price is the price at which the underlying asset can be sold or purchased by the holder of an option. After the expiry of the option period, the holder of the option shall decide whether to exercise his right to buy or sell at the price of the exercise.

 

B. Call and Put Options trading

There are two kinds of options used when selling options: call options and put options. A bought call option with a share as an underlying share gives the owner the right to buy shares on or before the expiry date of the option at a fixed price (the strike price). For this right, the investor pays an option premium.

The seller of the call option collects the premium and must sell shares at the exercise price while exercising the option. 'Writing an option' is often called selling an option.

 

For the right of a put option, the reverse is valid. A purchased put option with a share as an underlying option gives the purchaser the right on the expiry date to sell shares at the strike price. You may be allowed by the buyer of that option to purchase shares at the strike price with a written put option.

An investor with a call option exercises the right to purchase shares only if the price of the underlying asset is above the exercise price on the expiry date.

The holder of the call option will purchase the shares directly on the exchange at a lower price if the price is below the strike price. Please note: the buyer of the call option has the right, not the responsibility, to exercise the option. However as soon as the buyer of the option exercises it the seller should sell the shares.

In the case of put options, the reverse is valid. Only if the price of the underlying asset is below the exercise price does the investor exercise his option? In this case, by exercising the option, the investor can sell his shares at a higher price than the current price traded on the stock exchange. Here when the option is exercised, the seller of the option is bound to purchase the shares.

C. Long & Short Options trading

The phrases long and short are very common when trading stocks, options, and futures. In the language of the stock market, a long position means that the investor has purchased a certain commodity and speculates on a price rise.

Therefore, going short on stocks suggests that an investor sells stocks he does not own to buy them back at a cheaper price at a later date.

The margin between the sale price and the stock's lower purchasing price is the benefit of the investor. As the price of the stock increases, a long position makes a profit and when the price of the stock falls, a short position makes a profit.

The long and short terms take on an extra dimension in the field of choices. If an investor in his portfolio has long call options, it suggests that he has acquired these call options. The same applies to long-placed options, irrespective of the fact that the purchased put options speculate that the underlying value price will fall.

For short call and short put options, the reverse is valid ( written options ). In the table below, this becomes clear:

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