How many contracts in an option begins with a legally binding agreement between two or more parties, facilitating a transaction at a set price that is determined prior to expiration date; this is also known as the strike price. Simply put, the greater the likelihood of a certain occurrence, the greater the price of that option, when such an event occurs. Within the scope of options contracts, there are two types:

  • Put options, which are purchased as a means of earning a profit when the stock price declines.
  • Call options, which are purchased and essentially bet on the value of a particular stock.

If you are the buyer of a call option, then you have the right to buy the full number of shares being offered at the strike price, however, you are not obligated to do so. Meanwhile, if you are a put buyer in a put option, you have right to sell all of your stocks at the strike price determined in the contract, but again, you are under no obligation to do so.

Further Differences Between a Put and Call Option

Some further details regarding a call option is that a standard contract will generally cover 100 shares; however, this can be adjusted if and when mergers and acquisitions occur. Additionally, the terms and conditions of a call option contract specify both the strike price and the expiration date, holding both of these as legally valid.

While the expiration date will be clearly spelled out in the contract, you may wonder when the contract is opened; this occurs when the seller (also known as the writer) actually sells to the purchaser. At this point, the writer is paid, assuming the obligation of selling at the strike price. In cases in which the seller is holding those shares, it is a covered call.

A way to break this down is to assume that a writer (or, seller) might sell calls that are trading at $10 on the market, for $20, with a one-month expiration period. If the price of those shares remains under $20, then the seller can receive a premium by rewriting the calls and keeping the shares.

The flip side is what is called being in the money, and occurs when the share price goes above $20, in which case, the buyer calls the shares from the writer, thus purchasing them at the higher price of $20.

Now, with put options, the buyers are essentially betting on price declines of the stock, and they own the right to sell shares at the strike price that was determined in the contract. Much as with the call option, the expiration date is also spelled out in the contract of a put option; should the price of the stock drop below that aforementioned strike price before the agreed upon expiration date, the buyer has the option of either assigning shares to the writer, purchasing at the strike price, or selling the contract. However, the latter is only a viable option if the contract is not held within a portfolio.

Why the Expiration Date Is Important

Spelling out the expiration date is important because it determines when a stock is traded; generally, a stock will begin trading approximately eight months before the expiration date.

Additionally, after the determined expiration date, the option becomes worthless, leaving you without any means of exercising your rights regarding the stock. As such, it is crucial that you are always up to speed as to the expiration dates of your stocks, as you can lose all value you may have had in the option, should you not remember to exercise those options by the expiration date. While it may all seem rather confusing, the basic takeaway is to always be aware of the expiration dates!

Benefits of Buying Stock Options

There are many benefits to purchasing stock options, particularly if you are looking to leverage your investments and potentially increase income. Additionally, buying and selling options can be a less expensive alternative, as opposed to buying the stocks, themselves. It is important to be clear that buying and selling options is not the same as buying and selling stocks.

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