Stock Options: Call and Put Contracts

When investing in the Stock Market, Options are one of the best alternatives to make high returns. In addition to that, stock options allow us to leverage positions and manage risk. Therefore, knowing and understanding how they work is essential to use them successfully.

An option is the right (but not the obligation) to buy or sell a specific number of stock shares at a specific price for a predetermined period of time. If the acquired right is to buy, the option is called Call. If the acquired right is to sell, the option is called Put.

Options are traded through contracts. An option contract represents 100 shares of a company's stock. In this way, the two types of existing options can be defined as follows:

Call: A Call options contract gives the owner the right to buy 100 shares of an underlying stock at a specific price for a predetermined period of time.

Put: A Put options contract gives the owner the right to sell 100 shares of an underlying stock at a specific price for a predetermined period of time.

The specific price is referred to as the Strike Price or the Exercise Price. On the other hand, the period of time mentioned in the definition of Call and Put options is known as the Expiration Time. In option contracts, whether they are Calls or Puts, only the month in which the contract expires is indicated. By convention, the expiration date is the third Friday of this month.

So, let’s see how a Call works. Suppose the stock of a company is currently trading at $100. If we are the owner of a Call option contract with a strike price of $90 and expiration in October 2011, we have the right to buy 100 shares of that company at $90 each until the third Friday of October 2011. Therefore, if we exercise the contract at this time, the person who sold it (Option Writer) must sell the 100 shares of that company at $90. Thus, if we exercise our right to buy at $90, we can sell those 100 shares at $100 in the market, making a profit of $10 per share ($1,000 overall).

In the case of a Put, suppose the stock of that company is currently trading at $30. If we are the owner of a Put option contract with a Strike Price $32 and expiration in November 2011, we have the right to sell 100 shares of that company at $32 each until the third Friday of November 2011. Therefore, if we exercise the contract at this time, the person who sold it must buy the 100 shares of that company at $32. Thus, we can buy those 100 shares at $30 in the market and then sell them at $32, making a profit of $2 per share ($200 overall).

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