When trading options you will learn to read the chart in which you will see red and green candles forming. The colors of the candles are indicators in which direction the price is moving. The difference between a call and put option contract will be determined by which direction the market is moving. The green candle will indicate the price is rising up, which is known as a call. The red-colored candle will indicate that the pricing is dropping; which is known as a put.
Option Call Definition
A call option is essentially someone predicting that the price of the call option will rise. If the call option goes up, then the person who purchased the contract will make a profit. The goal is to sell the call contract and close your position.
To be profitable, one must sell the call before the option starts to head in the other direction. If this were to occur, then the person would lose money. To close your position would sell the call contracts back and collect the profit in which that trade would be officially completed. For a call buyer, the biggest loss is equal to the amount that the call was purchased.
The fact that there is no way you could lose more money than the amount you purchased gets the attention of buyers. It eases the buyer’s mind that to a certain extent your profit can be endless, and your loss is known and limited. If the current price of the option does not rise above the call start price prior to selling; the buyer loses the amount they paid for the contract. If the price of the contract goes above what it was initially purchased for, then the buyer makes a profit.
Option Put Definition
A Put option is someone making a prediction that the price of the option will go down. If the Put option goes down, the person who purchased the put will make a profit. The goal will be to sell before the Put option before it starts to go in the other direction. If this were to occur, then the person would then lose money. The max you can lose with a Put is the price you paid for it. So, if the stock goes up in price, your Put will lose value.
When selling a Put option, it is important to keep in mind the options contract value and profitability when considering a trade, or else you risk the stock falling past the point of profitability. The maximum gain is limited to the premium collected; while the maximum loss would occur if the stock fell to zero.
The price of a put option increases, the farther away from expiry it is. This is because of the chance the stock price will move before expiry. This provides a chance to the put buyer for which they need to be compensated for.
Strike Price vs Spot Price
It is important to know the difference between spot and strike prices, as these terms will come up in trading stocks. A strike price is a set price at which a derivative contract can be bought or sold when it is exercised. For call options, the strike price is where the security can be bought by the option holder; for put options, the strike price is the price at which the option can be sold. The spot price is the current price in the marketplace at which a stock can be bought or sold at that moment.
Which Is Safer, a Call or a Put Contract?
There is no upper hand of either initiating a call or a put option. What it falls down is the investment objective; which is to be profitable. The risk lies in the movement of the stock market. Which is why it is important to follow a proven strategy and not take a call or put options blindly.
Puts with a strike price above the current stock price and calls with a strike price below the current stock price are “in the money”; (ITM). The further the strike price is in the money, the more expensive that option will be because it has more value if exercised today.
An options contract is considered “out of the money”; (OTM), if the owner sold they would pay more than the current market value for a stock; in the case of a call option. In the case of a put option to sell a stock for less than its current market value.
At the money (ATM) is a situation where an option’s strike price is identical to the current market price; which essentially means you would break even. This can be used if you initially placed a call, but the market decided to go up then the price came back to where you initially purchased, you could exit without losing anything.
Summary of the Difference Between a Call and Put Option Contracts
Congratulations now you’ve learned the difference between a call and put option contract. When it would be in the option buyer’s best interest to start your position; which would be purchasing an option contract. When to end your options trading position, which would be when the option buyers determine it is best to sell an option.
The key is to remember that the difference between a call and a put option contract is whether the movement is heading upward or downward. You purchase a call if the movement is upward, and you purchase a put if the movement is downward. Stock price moving upward for a call is a profit, and price moving downward for a call is a loss. For a put, stock price moving downward is a profit and the price moving upward would be a loss.
Now it is time to tie a call and put it to something that will help you visualize and hopefully help you remember when thinking of your two options. Think of a rotary phone. When you dial out on the phone to start a conversation, it’s going outbound; so, this would be a call. When you would end the conversation, you would place the phone down, which would be a put.
Resources to Check Out!
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