Options trading for beginners

When you buy a stock you purchase partial ownership in the company. An option is a contract that gives the owner the right but not the obligation to either buy or sell the underlying financial instrument on wich it is based. Value of the stock option is in part based on, or derived from, the value of it’s underlying stock. I will try to explain this later in this post on one example.

There are two types of options on stocks: call options and put options.

Call option gives the owner the right, not an obligation, to purchase 100 shares of the underlying stock at a specific price per share (strike price) on or before the date of expiration. Call options are in common used when expecting the price of underlying stock to go up.

Put option gives the owner the right, not an obligation, to sell 100 shares of the underlying stock at a specific price per share on or before expiration date. Put options are in common used when expecting the price of the underlying stock to go down.

Example:

Let’s say that the value of XYZ company is $10. Trader thinks that the value of company will go up. He buys 10 call option contracts(controls 1000 shares) for $0.50 per share(that’s $500 for this trade) at strike price $11. Supposing that 1 month later the value of company is $12. Trader can use his options and purchase 100 XYZ shares for $11.000 and sell them for $12.000 or he can sell his option contracts for let’s say $1000. His gain would be $500 because he purchased options for $500 and sold for $1000. That’s 100% profit!