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Basic Options

Long Call

What is a long call?

A long call is a term used when you own a call option for an underlying asset. A call option is a contract where the buyer has the right (not the obligation) to exercise a buy transaction at a specific strike price at or before an expiration date.

In the world of trading, owing a long call means that you have a contract that gives you the right to buy the underlying asset at a specific price, before a maturity date. Once the contract is exercised, the contract disappears and the underlying asset will be part of your open positions at the specified strike price. If you had a short position on the asset beforehand, exercising this contract will be expressed as if you have covered your short position. The alternative of exercising would be to sell your option contract to another trader on the market.

What are its components? Can you show me how to have a long call in my open positions?

The components of a long call are quite simple. You simply need to perform an order to buy to open an option contract based on your desired specifications:LongCall1

When and why should I have a long call?

            You should have a long call option if you expect the stock price to go up, but would like to have a cushion of protection. As an example, if you own solely the underlying asset and the price goes down, the lost will have a stronger impact on the underlying asset than on the option contract.

What does it look like graphically? What is the payoff and profit graph? LongCall2

What is the break-even point?LongCall3

Short Call

What is a short call?

Recall that a call option is a contract where the buyer has the right (not the obligation) to exercise a buy transaction at a specific strike price at expiration date. A short call is a term used when you sell a call option for an underlying asset.

A trader that has a short call option is also referred as a trader that wrote a call option. This means that the trader wrote this option contract with a belief that the buyer of the contract will not exercise it. If this happens, the writer will pocket the premium from selling the contract. If the buyer of the call option does exercise his right, the writer will have to sell him the shares, with respect to the specifications of the contract. In other words, a call option writer has an obligation to sell shares of the underlying asset, contingent on the buyer’s decision to exercise his rights.

In the world of trading, a short position on a call option (“sell to open”) means that you sold a contract that gives the buyer of that contract the right to buy the underlying asset at a specific price at a maturity date. If the buyer decides to exercise his right, you are obligated to provide him the shares with respect to the requirements that you have both agreed upon. It is important to note that the seller of a call option has no exercising rights. Thus, the only way to close this option contract would be to “buy to close” or cover the contract in question.

What are its components? Can you show me how to short sell a call option on ST?

The components of a short call are quite simple. You simply need to perform an order to sell to open an option contract based on your desired specifications:shortcall1

When and why should I have a short call?

            You should short a call option if you expect the stock price to remain below the strike price. In a situation where the stock’s price is below the strike price, you will be able to gain the premium, since the buyer did not exercise his right. Evidently, writing a naked call (without being the owner of the underlying asset) can be very risky should the price surges beyond the strike price. Traders write options to implement it to certain strategies that will be discussed later.

What does it look like graphically? What is the payoff and profit graph?

shortcall2

What is the break-even point?

shortcall3


Long Put

What is a long put?

A long put is a term used when you own a put option for an underlying asset. A put option is a contract where the buyer of the put has the right (not the obligation) to exercise a sell transaction at a specific strike price before an expiration date.

In the world of trading, owning a long put means that you have a contract that gives you the right to sell the underlying asset at a specific price, before a maturity date. Once the contract is exercised, the contract disappears and the underlying asset will be sold at the specified strike price. If you already have the asset in your open positions, it will be sold at the specified price. If you do not own the asset, the sell action will be expressed as if you have shorted the stock. The alternative of exercising would be to sell your contract to another trader on the market.

What are its components? Can you show me how to long a put option on ST?

The components of a long put are quite simple. You simply need to perform an order to buy to open an option contract based on your desired specifications:Longput1

When and why should I have a long put?

            You should have a long put option if you expect the stock price to go below a specific price, but would also like to have a cushion of protection. As an example, if you short sell the underlying asset and the price goes up, the loss will have a stronger impact on the underlying asset than on the contract.

What does it look like graphically? What is the payoff and profit graph?

Longput2

What is the break-even point?
longput3


Short Put

What is a short put?

Recall that a put option is a contract where the buyer has the right (not the obligation) to exercise a sell transaction at a specific strike price before an expiration date. A short put is a term used when you sell a put option for an underlying asset.

A trader that has a short put option is also referred as a trader that wrote a put option. This means that the trader wrote this option contract with a belief that the buyer of the contract will not exercise it. If this happens, the writer will pocket the profits from selling the contract. If the buyer of the put option does exercise his rights, the writer must buy from him/her the shares, with respect to the specifications of the contract. In other words, an put option writer has an obligation to buy shares of the underlying contingent on the option buyer’s actions.

In the world of trading, a short position on a put option (“sell to open”) means that you sold a contract that gives the buyer of that contract the right to sell the underlying asset at a specific price, before a maturity date. If the buyer decides to exercise his right, you are obligated to purchase from him the shares with respect to the requirements that you have both agreed upon. It is important to note that the seller of a put option has no exercising rights. Thus, the only way to close this option contract would be to “buy to close” or cover the contract in question.

What are its components? Can you show me how to short sell a put option on ST?

The components of a short put are quite simple. You simply need to perform an order to sell to open an option contract based on your desired specifications:shortput1

When and why should I have a short put?

            You should short a put option if you expect the stock price to remain above the strike price. In a situation where the stock’s price is above the strike price, you will be able to pocket the premium, since the buyer did not exercise his right. Evidently, writing a naked put can be very risky should the price drop below the strike price. Traders write options to implement it to certain strategies that will be discussed later.

What does it look like graphically? What is the payoff and profit graph?

shortput2

What is the break-even point?

shortput3


 

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