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David Jaffee

How Do Calls and Puts Work?

When it comes to options trading, there are a few keywords to know. 

You will hear a lot about calls and puts as you learn to trade options and develop your strategy. 

But how do calls and puts work? 

David Jaffee of BestStockStrategy.com breaks down exactly how calls and puts work for his students, including the best strategy for options trading. 

If you find yourself searching for puts and calls for beginners, keep reading to learn how calls and puts work with examples of each. 

Call Option Meaning

The value of an option is connected to the price of the underlying asset. 

In many cases, the underlying asset is a specific stock. 

A call option gives the buyer the option to buy 100 shares of the underlying stock, but they are not obligated to do so. 

The call option buyer can purchase the underlying security at the specified price, known as the strike price, on or before the expiration date. 

A call option seller, or writer, can generate income by selling options and collecting option premium. 

The call option seller collects premium upfront from the buyer, which they keep whether the option is exercised or not. 

How does a call option make money?

For a trader who buys a call option, call options provide an opportunity to purchase a desirable stock at a lower price, while also providing favorable leverage when compared to owning stocks. 

If a call option is in the money, the stock price is higher than the strike price. This means the option buyer can purchase 100 shares of the specified stock at a price lower than the current market value. 

The call option buyer can also make money by selling an in the money option (and closing out the position) before its expiration date. 

For a trader who sells a call option, profit is earned by collecting option premium. 

If the option is not exercised by the buyer, the seller keeps the option premium as profit. 

If the option is exercised by the buyer, the seller may still earn a profit depending on the current market value of the stock. 

Call Option Example

A call option gives the buyer the right to purchase 100 shares of Amazon stock at a strike price of $3,250 per share with an expiration date in three months. 

If the call option buyer chooses to hold the option contract until expiration, they can purchase 100 shares of Amazon stock at the strike price.

The call option buyer also has the option of selling the contract before the expiration date.

In this example, the option seller may collect option premium of $5 per share, totaling $500 per contract. 

The option seller keeps the entire $500 option premium, and David Jaffee has taught more than 1,500 students how to earn a profit selling option premium. 

The call buyer will profit if the stock is trading higher than the strike price, plus the premium paid for the option, at the time of exercise. 

The call seller will profit if the option they sell is able to be bought back at a lower price than they sold it for. 

Put Option Meaning

Like call options, the value of a put option is linked to the underlying asset.

When a trader buys a put option, they have the right to sell 100 shares of the specified stock at the predetermined price (strike price) by the expiration date. 

Investors often use put options to speculate or as part of their risk-management strategy.

For the option buyer, a put option can help protect against downside price action and prevent losses on a stock by allowing them to sell their stock at a predetermined price (the strike price). 

Put option sellers generate income by collecting option premium in this scenario as well. 

Put option buyers have the option of selling the contract before the expiration date, and put option sellers collect premium regardless of the outcome of the option contract. 

How does a put option make money?

In general, as the value of the underlying asset falls, or volatility increases for the underlying asset, a put option will increase in value. 

If the price of the underlying asset increases, volatility decreases, or the option gets closer to expiration, a put option loses value. 

The put option seller is able to keep the entire premium and make money trading options if the option expires worthless (or it’s bought back at a lower price than it was sold for). 

Put Option Example

If the same 100 shares of Amazon in the earlier example are part of a put option, the option buyer pays a $500 option premium. 

If the price of Amazon falls below $3,250, the option buyer can short sell the stock at the higher strike price. 

The put option seller collects the $500 option premium, and they can keep the entire premium, but they can lose money if the market price of the stock falls too far below the strike price.

The reason the option seller can lose money is that the premium collected may not be enough to compensate them for the fall of the underlying stock.  

Should you buy or sell calls and puts?

David Jaffee of BestStockStrategy.com recommends selling option premium as a profitable option trading strategy, as long as it’s done correctly.  

While there is a potential for higher profits by buying options, selling options offers more consistency and less risk. 

Learn more about how calls and puts work, including the best options trading strategy at BestStockStrategy.com and earn $400 of free training materials. 

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