An option is a contract that gives you the right but not the obligation to buy or sell a specific asset at a specific price at a defined time. A call option is the right to buy an asset. A put option is the right to sell an asset. You can buy or sell puts or calls. If you buy a call, you purchase the right but not the obligation to buy an asset. If you sell a call, you are obligated to sell an asset if the buyer exercises the option. If you buy a put, you purchase the right but not the obligation to sell an asset. If you sell a put, you are obligated to buy an asset if the put holder exercises the option. Selling an option is sometimes called writing an option.
If you buy puts or calls, your risk of lose is the value of the premium you paid to purchase the option. If you sell a put or a call, your risk is the total value of the asset minus the premium you receive for selling the option. Selling an option exposes you to more risk than buying an option does. Indeed, your risk may be open ended although in practice it is usually not unlimited.
Most options are traded with an exchange. If you buy the option, you pay the exchange a premium for the put or call. The option will have an expiration date after which it has no value. It will have an exercise date or range of dates. These are the dates when the owner of the option can decide to make the seller of the option fulfill the contract.
If you sell an option, you receive a premium from the exchange. You may be required to put up initial margin to cover possible price movements in the option. The option is marked to market each day and you will have to put up additional margin if the price of the asset has moved against you. Conversely, you will receive margin from the exchange into your margin account if the price moves in your favor.
Comment Preview