4.5.6.1. Simple Options: Puts and Calls
Imagine that Google is currently trading at $500 and you believe that Google stock is going to rise quickly in the near term. Maybe you think it will climb to $550 within the month. You would like to buy shares in Google and profit from your belief that the price will rise, but you don’t want to commit to the whole price of the stock at this time.
Instead of buying shares of the stock, you could buy a Google call option, which will give you the right to buy a set number of shares in the future at a specific price. This price is called the strike price.
This call option gives you the right to buy 100 Google shares at the strike price, regardless of how high the market price of Google rises. Options don’t last forever, however; they usually only last for a few months. What happens if Google stock doesn’t go up as you expected? Then the option will expire and you’ll have lost the cost of the option.
For every option that has a buyer, there is also a seller. The seller will receive the money that you paid for the option, but he is then obligated to deliver the stock to you if you decide to exercise the call option and buy the security. The seller of a call option has an obligation to sell at a strike price. So the seller of the call option is hoping that the price of Google will not rise. If the stock price rises high enough, he will lose the cost of the premium and more.
When an investor purchases an option, we say he is long the option, or the holder of the option. When an investor sells an option, we say that he is short the option, or that he writes an option.
If you expect that the price of Google will fall quickly, you cou