- An investor who buys a call option gets the right to buy a stock at a predetermined price. The option lasts for a fixed amount of time stated in the contract. For the option to be used, the stock's price must move above a minimum price level. If the stock never goes above the minimum price level during the contract period, the option becomes worthless. Buying call options is significantly less expensive than buying their underlying stock. If an investor believes a share price will rise, buying call options lets her leverage her investment into a large gain.
- An investor who sells a call option enters a contract to sell a share at a specified price, no matter how high the share is trading in the stock market. He receives an immediate cash gain for writing the call option. Selling call options works well if the underlying stock drops in value or stays the same. They can create a significant loss if the stock goes up in value as the potential for loss is limitless.
- Buying a put option gives an investor the right to sell a stock at an agreed price, no matter how low its current market price. Like call options, this contract expires over time. The underlying stock price must drop below a stated price for the option to be used. Put options can give a large gain if the underlying stock drops in value. They become worthless if the stock price never goes below the stated contract price.
- An investor who sells a put option enters a contract to buy a stock at a certain price, no matter how low its actual market price. She receives an immediate cash gain for writing the put option. Selling put options works well if the underlying stock gains in value or stays the same. They can create a significant loss if the stock price has a steep drop in value.
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