There are four different types of players in the stock option trading game. They are buyers of calls, sellers of calls, buyers of puts, and seller of puts. The buyers are called holders, and the sellers are called writers. Buyers of calls are said to have a long position, while buyers of puts are said to have a short position. Calls are useful in speculation, and puts are useful in hedging.
It is all going to depend on the strike price of the underlying asset on the expiration date. If all of this makes perfect sense to you, there is not much need to read on, but if it sounds a bit hazy, a little review might be in order. The Stock Option market has its own unique language. Like many other activities, an understanding of the terminology used is essential.
In many cases, it is a rather simple concept hidden behind an unknown term that leads to confusion, and makes the activity appear a lot more complex than it actually is. The following are a few definitions that might help take away some of the mystery. - Calls: A call is basically a contract giving you an option, but not an obligation to purchase a block of stocks at a set price on or before a certain date. In understanding a call, it is important to remember that you are not obligated to make the purchase. You can exercise your option or not.
- Puts: A put is the opposite of a call in that it is a contract to sell a block of stock at a set price on or before a certain date. Again, this is a choice. You can make the choice not to sell. - Holders: This is the name given to the buyers of the contracts. It is the holders that give the option trading market its name since they are the ones who actually are in a position to make the decision to exercise their options.
- Writers: Since it is a "trading" market, two parties are necessary. If someone is buying, than someone else must be selling. The writers are the sellers of the contracts. It is important to remember that the writers are not the ones with the options. They do have an obligation to honor the contract if the holder decides to exercise his option. - Long Position: In stock trading, long position means that you are holding the stock in anticipation of it increasing in value.
- Short Position: In stock trading, short position means that you are holding the stock in anticipation of it decreasing in value. - Underlying Asset: The underlying asset, or as it is sometimes called, the underlying, is the actual stock or security that is the object of the option contract. The contract is said to derive its value from the intrinsic value of the underlying asset. - Strike price: This is the price at which the option contract will be purchased or sold. If you purchase an option to buy, or make a call, at $10 , but the value of the underlying asset is only $8, you are $2 under the strike price, and most likely would not wish to exercise your option. - Speculation: This is the risk taking side of option trading.
It is generally associated with calls and long positions. It essentially means that you are expecting a stock price to rise higher than the strike price. - Hedging: This is the cautious side of option trading. It is generally associated with puts and short positions.
You are anticipating that the value of the underlying asset will drop below the strike price. It is called hedging because it is often used to protect an investment, or hedge your bet, by maintaining an option to sell at a certain strike price should the underlying asset take a serious drop in value. In other words, you are able to bail out before your loss becomes too large. - Expiration date: This is the date on which your option must be exercised or it will be lost. It is the deadline. In the stock option market it is usually the third Friday of a month.
The above are a few of the terms that are used in the stock option trading market, and by understanding them completely you should be better armed to take a closer look at this interesting investment opportunity.
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