Thursday, July 18th, 2019

How Do Puts and Calls Work?

 

Puts and calls are types of options contracts. How do puts and calls work? In trading both puts and calls the options trader pays for the right to sell using a put option or right to buy using a call option. Puts and calls are used in trading stocks, commodities, or foreign exchange. The buyer of a put or call retains the option to sell or buy the underlying equity at the contract price, also known as the strike price. The seller of a put or call receives payment and agrees to buy or sell at the strike price no matter what the market price is should the buyer choose to execute the options contract. How do puts and calls work for the various types of underlying equities? When to buy puts is when the investor or trader believes that an equity will go down in price. When to buy calls is when he believes the underlying equity will rise in price.

How do puts and calls work in trading stocks? A trader will study stock fundamentals and then study market prices with technical analysis tools. How to trade options on stocks is to decide if the stock price is likely to rise or fall. Then the trader buys a call option for a stock which will probably rise in price or a put option for a stock that is likely to fall in price. Because the buyer of an option is under no obligation to buy or sell stock he need not execute the contract if the price movement of the stock moves against him. If the price of the stock moves in the expected manner he will execute the contract. For a put option he will be able to sell stock at the contract price even if the stock has fallen in price. For a call option he will be able to buy stock at the contract price even though it has risen in price. In each case his profit is the difference between contract price and market price, minus the premium paid for the option and fees and commissions from the purchase or sale of stock.

How do puts and calls work in trading commodities? Puts and calls on commodities work in a similar fashion to puts and calls on stocks. In the case of commodities the buyer is purchasing the right to buy or sell futures on commodities such as corn, cattle, oil, or gold. Holding an option insures him against the risk of an unexpected price movement as he never has to execute the contract. If, however, his analysis is correct and wheat, corn, oats, oil, or silver futures skyrocket he will be able to buy at the contract price and then sell at the much higher spot price for a sizable profit. In the end how to trade futures options is not so much different from trading stock options. Only the underlying is different.

How do puts and calls work in trading foreign exchange? There is symmetry to trading two currencies such that buying calls on Yen with dollars is really the same as buying puts on dollars with Yen. Think of buying dollars with Google stock and you will be on track. As Yuan options trading begins in China next year traders will be able to buy puts and calls on the Yuan with a range of foreign currencies.

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