Puts and Calls

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An option is a contract that gives the holder, for a stated period, certain rights with regard to the underlying security of that option (options are available based on stocks, stock indices, commodities, currencies, even interest rates). There are two types of options: calls and puts. For simplicity's sake, we will discuss options in terms of stocks, as these options are the oldest and best known. Call — A contract that gives the holder (buyer) the right to buy a fixed number of shares — normally 100 — of stock for a specified price (the striking price) within a specific predetermined time (up to the expiration date). Put — A contract that gives the holder (buyer) the right to sell a fixed number of shares — normally 100 — of the stock at a specific price (the striking price) within a spe­cific predetermined time (up to the expiration date). The holder of a put or call contract is always called the buyer or holder. The person who undertakes to fulfill the contract is always called the writer or seller. To acquire an option, the buyer pays the writer a premium. The table below will help you understand the relationships between the buyer and writer for each type of contract. Type Position Terms of Contract Premium Investment Attitude Call Buyer (Holder) Can exercise option to buy stock at a certain price within a certain time, regardless of stock's market price. Pays premium to writer. Hopes stock will rise enough in price within the time limit so that exercising the option will produce a profit after deducting the original premium paid. Call Writer (Seller) Must sell stock at agreed –upon price if option is exercised by holder. Receives premium from buyer. Hopes stock will not rise enough for option to be exercised within time limit. Put Buyer (Holder) Can exercise option to sell stock at a certain price within a certain time, regardless of stock's market price. Pays premium to writer. Hopes stock will decline enough in price within the lime limit so that exercising the option will produce a profit after deducting the premium paid. Put Writer (Seller) Must purchase stock at agreed –upon price if option is exercised. Receives premium from buyer. Hopes stock will not decline enough for option to be exercised within time limit.