However, you are under no obligation to do so. Buying put options is a way to hedge against a potential drop in share price. They could also reap profits from bear markets or declines in the prices of individual stocks. You should also understand the risks associated with put option investing, though. Because options are derivatives , they receive their value through an underlying security.

This reliance on other securities makes options generally more complicated and risky than investors who focus on individual securities, like stocks and bonds. In the worst-case scenario, losses for some derivatives can be nearly limitless, so tread lightly. Since you own the shares, this is called a covered option. To buy put options, you have to open an account with an options broker.

The broker will then assign you a trading level. That limits the type of trade you can make based on your experience, financial resources and risk tolerance. To buy a put option, first choose the strike price. This will normally be somewhat below where the stock is currently trading.

Next choose an expiration date.

This could typically be from a month to a year in the future. Longer time periods generally mean less risk. Next decide how many contracts to buy. Each options contract is for shares of stock. For each contract you will pay the listed premium for that option, plus brokerage fees.

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You can exercise the option at any time before the expiration date. Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range can also impact how and where products appear on this site. While we strive to provide a wide range offers, Bankrate does not include information about every financial or credit product or service. Call options are a type of option that increases in value when a stock rises. Call options are appealing because they can appreciate quickly on a small move up in the stock price.

So that makes them a favorite with traders who are looking for a big gain. For this right, the call buyer will pay an amount of money called a premium, which the call seller will receive.

Unlike stocks, which can live in perpetuity, an option will cease to exist after expiration, ending up either worthless or with some value. One option is called a contract, and each contract represents shares of the underlying stock. Exchanges quote options prices in terms of the per-share price, not the total price you must pay to own the contract.

Call options are in the money when the stock price is above the strike price at expiration.

🤔 Understanding a call option

The call owner can exercise the option, putting up cash to buy the stock at the strike price. Or the owner can simply sell the option at its fair market value to another buyer. A call owner profits when the premium paid is less than the difference between the stock price and the strike price.

If the stock price is below the strike price at expiration, then the call is out of the money and expires worthless. The call seller keeps any premium received for the option. While the option may be in the money at expiration, the trader may not have made a profit. Only above that level does the call buyer make money. When comparing in percentage terms, the stock returns 20 percent while the option returns percent.

For every call bought, there is a call sold. So what are the advantages of selling a call? In short, the payoff structure is exactly the reverse for buying a call. Call sellers expect the stock to remain flat or decline, and hope to pocket the premium without any consequences.

Coming Attractions

The appeal of selling calls is that you receive a cash premium upfront and do not have to lay out anything immediately. Then you wait until the stock reaches expiration. Just ask traders who sold calls on GameStop stock back in January and lost a fortune in days. However, there are a number of safe call-selling strategies, such as the covered call, that could be utilized to help protect the seller.

The other major kind of option is called a put option, and its value increases as the stock price goes down. In this sense, puts act like the opposite of call options, though they have many similar risks and rewards:. For more, see everything you need to know about put options. While options can be risky, traders do have ways to use them sensibly. Of course, if you still want to try for a home run, options also offer you that opportunity, too. How We Make Money.

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