There are essentially two types of options:
1. Call Option
2. Put Option
For each of the Call/Put, there will be buyer and seller. Let us look into each of the scenario. We will go through “buyer” perspective for both Call and Put before touching on “seller” perspective.
Call Option
Buy Call: When an investor buys a Call, he is buying the right to purchase the underlying stock (100 shares) at the specified fixed price (strike price) by the specified date (expiration) in the future. To re-iterate the examples given.
Example 1:
Mr. A buys “1 AIG Aug 12 Call at $1.50”.
Mr. A is buying the right to purchase 100 shares of AIG at the price of $12/share between the point of transaction till the expiry date.
Mr. A pays $1.50/share (the premium) to attain this right.
So a Call buyer would profit if the share price goes up. A Call buyer is bullish on the stock.
Suppose at the end of the expiration, AIG stock has risen to $17/share, the buyer would close the transaction and make $5 gain ($17-$12) on the stock, “EXCLUDING” transaction fees and premium paid.
Put Option
Buy Put: When an investor is buying a Put, he is buying the right to “sell” the underlying stock (100 shares) at the specified fixed price (strike price) by the specified date (expiration) in the future.
Example 2:
Mr. A buys “1 AIG Aug 12 Put at $1.50”.
Mr. A is buying the right to Sell 100 shares of AIG at the price of $12/share between the point of transaction till the expiry date.
Contrary of buyer of Call, the buyer of Put is bearish of the stock. A Put buyer would profit if the share price drop.
Suppose at the end of the expiration, AIG stock has dropped to $9/share, the buyer would close the transaction and make $3 gain ($12-$9) on the stock, “EXCLUDING” transaction fees and premium paid.
On my next post, I will touch on sellers' perspective for both CALL and PUT.
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