When you acquire an option, you are getting the right to either buy or the right to sell shares of a certain security.
You have the right but not the obligation to do so.
When talking about a call option, the right is for purchasing the shares.
Call options give you not just the right to buy a stock.
They also give you the right to do so at a predetermined price and by a specific expiration date.
The predetermined price is called a strike price.
In the U.
S.
, the shares can be purchased at any time before the expiration.
Should the call buyer decide to purchase the shares, the seller must sell them at the strike price already agreed upon.
When a call buyer makes this purchase, it is said that he or she is exercising the option.
The right to sell shares of a security at a strike price which is predetermined is called a put option.
Put options also come with an expiration date for exercising the option.
If a put buyer decides to sell the shares, they have to be purchased at the strike price that has been agreed upon.
Puts can confuse you a bit with their terminology.
Put buyer refers to the person who has purchased the put option.
But this person is the one who is the seller of the shares.
With either a put or a call option, the buyer of the option is considered to have the long position.
The people on either side of the options are hoping that share prices will fluctuate in their favor.
With call options, for example, the buyers are doing so with the hope that the share prices will increase.
In this case, by making the purchase at the strike price that is lower, the buyers can make a profit.
The sellers are hoping that the prices will drop so that they do not lose money.
In the case of put options, the opposite is the case.
The put buyers hope that the share prices will fall.
The put writers, therefore, are hoping that the share price will go up.
In most cases with options, shares do not end up changing any hands.
A person who is taking part in a call option can also be involved with a put option.
A common use of options is in managing portfolios.
Whenever options are purchased, a premium must be paid for those rights.
European options are different from American ones with regards to the expiration dates.
In Europe, options may only be exercised on the expiry date itself and not before.
American options can be exercised any time up to that date.
Models are used to try to figure out the value of an option and there are several of them.
The most basic used is the Black-Scholes model.
Models must take several factors into account including the security price at that time, the option strike price, the cost of holding a position, the estimated security volatility during the option and the time to expiration of the option along with any restrictions.