You may have heard that most options will expire worthless. In reality, the saying is only used to teach traders that you need to have caution whether you’re buying or selling options. Choosing which is better is a personal preference, but this explanation may help you pick your path.
Options
An option is a contract promise that comes with a time limit. The contract offers the buyer the right to buy or sell a security or other financial asset at a price (strike price) during a period of time or on a specific date (exercise date). They have no obligation, but there is an opportunity. If they choose not to, they can allow the option to expire. Options are extremely versatile securities and can include anything from commodities to stocks.
Buying a Call Option
Buying a call is when someone has the right (but not the obligation) to purchase an asset at the strike price by a future date. For example, if you have insider knowledge that the price of a stock is likely to rise, you may want to buy a call option for the stock at the current price of $50 when you think the stock price may go up to $60. If the stock increases in price, you can purchase it for $50 per share. The stock may also decrease, which means you have the right to refuse to buy the stock and only lose the amount you used to purchase the call. The amount used to purchase a call is known as an option premium.
Buying a Put Option
Buying a put option is like purchasing insurance against an asset that could decrease in value. Like buying, a put option is a contract between two parties to exchange securities or goods at a strike price by a predetermined date. The buyer has the right (but not an obligation) to sell their stock at the strike price by the future date. As an example, you may think that your assets could drop in price from $50 to $40, so you buy a put to guard yourself against loss. The stock may drop significantly, and you could exercise your right for the seller to purchase your stock with minimal loss to yourself. The stock could remain the same or increase in price, meaning you’d just lose your option premium.
Selling a Call Option
Selling a call is when someone has an obligation to sell options to a buyer at the strike price if the right is exercised. For example, you have stock in a company that you suspect could drop in price from $50 per share to $40 per share. Someone wants to buy your stock, and you’re willing to sell. You accept the option premium, locking you into the contract. The stock could go up or down, and you have an obligation to sell the stock at the call price. However, if the buyer doesn’t exercise their right, you are allowed you to keep your stock and the option premium.
Selling a Put Option
Selling a put option is almost like being an insurance agent against loss for another party, while also having the chance to make a profit if you think an asset will continue to perform well in the market. The seller of a put has an obligation to buy the stock from the buyer at the strike price if the right is exercised. Using the example above, a buyer of a put could have purchased a put with you on a stock you believe won’t decrease in price. If the stock does well, and the buyer doesn’t exercise their right, you get to keep the option premium. However, the stock could drop, and you could be obligated to purchase the stock at the agreed upon price.
