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The last two weeks have seen significant market action in both directions. And it's just more proof that you need options in your portfolio to help cut your risk and boost your potential returns. Traditional buy-and-hold investors have been taken to the cleaners by whipsaw markets.
I don't want that happen to you.
Increased volatility will continue as we head into September and October. So I want take this opportunity to reexamine some of the fundamentals of options to help reinforce your understanding of the more sophisticated topics we've been covering lately. It's crucial that you have a strong grasp of the fundamentals, especially if you're new to the material - you won't be a master trader until you have this stuff down.
If you're familiar with options, this a great opportunity for you to brush up on the basics - you may even learn something new. If you're new to options trading, you've picked the perfect time to join us.
So let's take a step away from the market chaos and get back to basics...
The Difference Between Calls and Puts
Let's start from the beginning with a very simple definition - an option is a contract that gives the owner the right to buy or sell a financial product at a specific price on or before a specific date. When dealing with equity options (like we do in my Power Profit Trades free e-letter), that financial product is usually a stock or an ETF.
A call option gives the owner the right (but not the obligation) to buy the underlying instrument on or before the expiration date. You profit on a call when the underlying instrument increases in price.
A put option gives the owner the right (but not the obligation) to sell the underlying instrument on or before the expiration date. You profit on a put when the underlying instrument decreases in price.
Calls and puts are bought to establish a long position or sold (also known as writing) to establish a short position. However, selling to open an options position obligates the seller (or writer) to fulfill their end of the contract.
If you sold calls, that means you must sell the underlying; if you sold puts, that means you must buy the underlying. When you sell calls, you have no control over whether or not a contract is exercised.
Writing options is very risky unless you put on a simultaneous long play to cut that risk. Subscribers to my Money Calendar Alert investing service do this all the time with my recommended "loophole" trades.
The term for the specific price at which an option contract is exercised is the strike price. The number of available strikes (options) on a given stock or ETF is dependent on a multitude of factors...
About the Author
Tom Gentile, options trading specialist for Money Map Press, is widely known as America's No. 1 Pattern Trader thanks to his nearly 30 years of experience spotting lucrative patterns in options trading. Tom has taught over 300,000 traders his option trading secrets in a variety of settings, including seminars and workshops. He's also a bestselling author of eight books and training courses.