But like, What are Options?

Options can be (are) risky. There are two types, and you can buy them and sell them both in different ways. An option is a contract that gives its owner the right to control 100 shares of a certain stock. When buying options, the premium is how much the person pays for the option per share of stock. For example, a $165 strike price call option for Apple ($AAPL) stock expiring on November 19 costs $3.55 per share or $355. That last sentence probably created quite a few questions like, “Options expire?” and “What is a strike price?,” but I think the best way to explain is through an example.

Let’s first talk about a call option. For this example we will use the Apple call option from above. Basically what owning a call option on a certain stock means is that you have the right to buy 100 shares of that stock at the set strike price before or on the expiration date. So, if on November 10, Apple stock is at $170 per share, I could exercise (use) my option and buy 100 shares of AAPL stock for $165 (strike) + $3.55 (premium) per share, making myself a profit of $1.45*100 or $145. But, if instead, Apple drops to $140 before November 19 and stays there, I would obviously not want to buy 100 shares of Apple for $165 each, so my option would expire, and I would completely lose the $355 I spent on the premium. This is why options can be more risky than just owning stock. With stock, the only way to lose your whole investment is for the company you own to go bankrupt, but with options you could lose the entire premium that you invested if you do not have the correct price or right time frame the strike and expiration. Buying call options is a high risk, high reward game. Options are also a game that you have to buy in big to play. Another downside of this trade is that I would need $16,855 in order to execute it to pay for the stock and premium, and off that almost $17k, I would only make $145, or a 0.86% return, and that is only IF Apple were to rise to $170 within a month.

Now we can get into put options. Essentially, a put option does the opposite action of a call option. A put option allows you to sell stock at a certain price before a certain date. We can use another Apple example. Currently, Apple is trading around $155 per share and I own 100 shares. But, I’m worried Apple stock might go down soon for any number of reasons. I decide to buy a put option with a strike price of $155 for $7.38 per share, expiring on November 19. So, now if Apple stock drops below $155, I can exercise my put option and sell it for $155, but this is not actually true because of the premium. Apple stock would have to drop significantly down to $147.62 ($155-$7.38) for me to even break even on this trade. This makes put options not the best solution for downside protection.

This article was just meant to serve as a simple guide to what call and put options are and what buying them does. Selling options can get a bit more complicated, but I will be back with more on that very soon.