CALLS and PUTS are the CORE of Trading Options
Before I explain to you the difference between calls and puts and the importance of why traders should use these tools in their arsenal – you should understand the following:
What is a Call Option?
A Call option is a legally binding contract between two parties that gives the buyer the RIGHT, but not the OBLIGATION, to BUY 100 shares of stock at the purchased strike price on or before the expiration month.
Why Should You Trade Calls?
There are several benefits for trading call options. Some of the most notable include the following:
I want to buy 1000 shares of XYZ stock that is trading at $20 per share. Instead of putting out $20,000 to buy the stock – by utilizing the power and leverage (and a newfound understanding of calls), I decide to purchase 25 call options that expire in 6 months. Knowing that XYZ stock is up-trending, looks good on the chart, has strong fundamentals, and has new upcoming product release in the next few months – I decide to BUY 25 Calls for $2 each equaling a total trade cost of $5,000. I not only get long 1000 shares of stock by doing this, but as the trade moves in my favor, my shares will increase in size. I am able to use 75% less capital using this strategy of buying the calls versus buying the stock outright, with a more attractive upside potential.
What is a Put Option?
A put option is a contact between two parties that gives the buyer the RIGHT but not the OBLIGATION to SELL 100 shares of stock at the purchased strike price on or before the expiration month.
Why Should You Trade Puts?
There are several benefits of trading put options. Although not as popular and heavily traded as calls, puts are very powerful in the following ways:
- It is important to note that both CALLS and PUTS are very much alike and share the same benefits. The only main difference is when buying:
Puts make you money in downward moves, while Calls make you money in upward moves.
I want to sell short 1000 shares of ABC stock that is trading at $40 per share. Instead of forking out $40,000 to short the stock, utilizing the power and leverage (and a new found understanding of puts) I decide to purchase 25 puts options that expire in 6 months. Knowing that ABC stock is down-trending, looks bearish on the chart, has poor fundamentals, and just released a negative news alert – I decide to BUY 25 PUTS (6-months until expiration) for $4 each equaling a total trade cost of $10,000. I not only get short 1000 shares of stock by doing this, but as the trade moves in my favor, my “short directional exposure” increases. I am able to use 75% less capital using this strategy of buying the put options versus selling short the stock.
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