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The Basics of Stock Options

The Basics of Stock Options

When people have extra money they wish to invest, they can do this by purchasing stock options. Hopefully, this article can give you the basics of how stock options work.

First, what are stock options?

It is an agreement between two parties. This contract gives the buyer the right to buy or sell a stock at a particular price. The buyer can exercise this right until an agreed-upon expiration date.

It that gives the buyer the right to buy a stock is called a “call.” The option that offers the buyer the right to sell a stock is called a “put”. And these options can be used at any time up until the expiration date.

Stock options usually come in groups of 100 shares. The group of 100 is known as a “lot”. And the price the lots are bought or sold at is known as the “strike price”.

Here’s an example of a put stock option:

Let’s say you want to buy a stock option of the Ramey company. Let’s say the price of the stock is $210. So you buy one put stock option (which equals 100 shares) at a strike price of $200. And let’s say this option expires in six months.

If the Ramey company’s stock price falls to $190 before the six months is up, you can exercise your right to sell the option, equaling 100 shares of the Ramey company at the original strike price of $200. You can do this anytime before the expiration date is up.

That is, when the Ramey company stock is at $190 a share, you can buy 100 shares of the stock at $190 and sell them for $200 a share. So you make a profit of $10 a share, even though the stock price went down.

Now here’s an example of a call stock option.

Let’s use the Ramey company’s above example, except you are buying a call option for $200. And let’s say this time, the stock price rises to $300. Now what you can do, is exercise your option to buy 100 shares of the Ramey company at $200 and then sell them at $300!

Things to keep in mind:

If you buy a call option, and the stock price never rises above the strike price, the option will be worthless once the expiration date is reached. And of course, this holds for a put option: if the stock price never falls below the strike price, the option will be worthless at the time of the expiration date.

And, of course, there is the cost of the option itself. This is called the “premium” of the option.

There are many places to learn more about stock options. It is suggested that you go online to the various websites that discuss stock trading and options before you get too involved. And please make sure that you don’t spend money you can’t afford to lose. Good luck!