| The world of option trading may seem quite daunting | | | | that that the underlying asset will fall in value. This |
| to a beginning trader, but in reality, there are only | | | | type of option is an excellent instrument to have |
| two types of options, Calls and Puts. Once you | | | | when you are trying to guard against losses in stock, |
| understand these terms, knowing which option to | | | | futures contracts, or commodities that you presently |
| buy will become almost second nature.This article will | | | | own. |
| discuss these two types of options at a beginner | | | | Put options give the buyer the right, but not the |
| level. It will not be very complicated nor will there be | | | | obligation to sell a specific quantity of the underlying |
| any horrible maths involved! | | | | asset at a predetermined price (ie the strike price) |
| Calls | | | | during a certain period of time. Like call options, if you |
| Call options can be thought of the buyer taking a bet | | | | choose not to exercise a put option before its expiry |
| that the underlying asset (ie a certain parcel of | | | | date, the total amount of money lost is the price |
| shares, futures contract, etc) is going to rise in value. | | | | paid for the option. However, as the price of the |
| It gives the buyer the right, but not the obligation, to | | | | underlying asset drops in value, this drop in value is |
| buy a certain asset for a certain price (called the | | | | offset by the put option, which increases in value at |
| Strike Price) before a certain expiry date. In essence, | | | | the same rate the underlying asset is decreasing in |
| what you are doing is buying an opportunity. If you | | | | value |
| don't buy the asset before the option expires, you | | | | An easy way to look at put options is to think of it |
| lose only the amount of money that you spent on | | | | as an insurance policy. If you have an insurance policy |
| the option, which is usually only a small fraction of the | | | | on your home that costs $500 for a year's |
| value of what the option controlled! You can always | | | | protection from damage, if you go through the entire |
| sell the option before it expires, either at a profit or | | | | year without any damage, you have only lost $500. |
| to minimise a loss. Another choice is to exercise the | | | | However, if your house is severely damaged (is has |
| option, which means you actually want to buy the | | | | lost value), you can repair it (it maintain its value) with |
| asset it controls. As long as you have purchased the | | | | the insurance policy, which had only cost you $500, |
| option, you can exercise the option at any point if it | | | | but paid for thousands of dollars in damage. The |
| is an American-style option (European-style options | | | | same thing can be applied to a share portfolio. |
| can only be exercised on the expiry day) | | | | So that's all there is to it. If you think a share price is |
| Puts | | | | going to go up in value, buy a call option, as they |
| Put options can be thought of as the buyer betting | | | | increase in value with a rising market. |