Put and call option

An option is one of the complex financial instruments, which is a contract that gives the trader the right to buy or sell a certain asset at a given price at a specified time. This investment instrument is used to hedge risks and make profit from speculative transactions. There are two types of option agreements: put and call.

What is a put option

A put option is a futures contract that gives its buyer the right to sell assets at a predetermined price at a predetermined time.

If an unfavorable situation arises (for example, a forecast of an upcoming reduction in price or price reduction), the trader has the right to sell the contract earlier than the agreed date. The decision to sell a financial instrument is made solely by its owner and may depend on current sentiment on the stock exchange. In this case, the buyer is obliged to purchase the asset, even if it is not profitable for him at the moment.

What is a call option

A call option is an agreement that operates inversely to a put option. It gives the buyer the right to purchase an asset at a pre-agreed price at a certain point in time, in the buyer’s interest for the asset to rise in price before the end of the contract period. If the situation develops unfavorably, the trader has the right to change his decision and refuse to purchase the underlying investment instrument. In this case, the seller has no right to choose. He is obliged to sell the asset at the first request of the buyer.

The compensation to the seller upon completion of the transaction is offset by an irrevocable premium. A certain amount is paid to the owner of the securities during the process of concluding the agreement and is not refundable, regardless of whether the agreement is fulfilled within the agreed period or the other party to the transaction changes his mind about buying the asset.

Difference between put and call options

The main differences between put and call contracts are:

Under the terms of a call agreement, the trader is given the right (but not the obligation) to purchase an asset on a certain date at an agreed upon price. A put gives the trader the right (without obligation) to sell an asset at a predetermined price at a specific time.

A call option makes a profit if the price of the underlying asset rises. The difference between a put option and the previous one is that it provides benefit when the value of an asset falls.

The buyer’s potential profit from transactions with call agreements is unlimited. In the case of put contracts, there is already a return limit on the holder’s income.

Despite the many significant differences between these investment instruments, the maximum loss from transactions with both types of contracts is not limited for the seller, and for the buyer is determined by the size of the premium.

Where are these options used?

Options are often used in speculative trading strategies. But due to the fact that this instrument is highly complex and involves an uneven distribution of risks between the seller and the buyer, many traders prefer futures.

The second important application of put and call contracts is hedging. This is the protection of investments from the risk of adverse changes in the value of assets using derivative financial instruments. Options contracts are ideal for this purpose.

If an investor wants to insure his investments against rising prices for underlying assets, he takes a long position (concludes a call option agreement). A put option works in a similar way to hedge the risk of a decline in the value of financial instruments.

Real stock options have nothing to do with so-called binary options

. The latter are mainly used by fraudulent companies that do not provide traders with the opportunity to earn money, but are focused only on taking money from them.

Options are used for hedging due to the use of an unsecured margin trading mechanism (leverage). As a result, options trading involves high risk.

Options are more often used by large investors, such as hedge funds. Private investors use them to make speculative profits. At the same time, there are many options trading strategies that actually break even. However, in order to succeed, you need to strictly follow their rules.

options

The difference between binary and stock options

To begin with, it is worth understanding that there are real options, these are stock options that are traded on the derivatives market, for example, on the Moscow Exchange. There are also so-called binary options that have nothing to do with exchange trading. Accordingly, many of the fears of traders regarding the loss of money are associated with the concept of binary options, which can often be seen on the Internet. Let’s take a look at what is the difference between binary options and ordinary options, that is, stock options.
There are a number of markets on the Moscow Exchange, and the most famous of them are stock (stocks, bonds, shares), foreign exchange (conversion of different currencies) and futures (options and futures contracts).

An option is a contract for the purchase / sale of the underlying asset (the underlying asset for options are similar futures) until a certain date in the future on the terms specified in the specification of the option contract.

In fact, traders on the Moscow Exchange use these tools for various purposes:

• to insure positions – both in stocks and the portfolio as a whole, in futures;
• to make money on a non-linear market change — with the help of options, you can earn on a price not leaving the range or on a sharp impulse in any direction, as well as in many other situations;
• to make money on directional market movement – if the market is rising or falling.

 

There are a huge number of options for dealing with stock options, and each of them requires a different level of trader’s training. We advise beginners to first start studying stock options from the moment they buy their first share, since this tool allows you to insure, or, as stockbrokers say, “hedge” risks.

 

For example, if a futures on Sberbank shares (futures are the underlying assets for options) costs 14,750 rubles. When buying it, you do not know at what price you will close the deal (sell the futures). But by buying a put option (the right to sell a futures on Sberbank at 14,750 rubles for a month for 460 rubles), you insure the position in advance – if the futures price falls, you can sell it at the purchase price. But for the possession of such a right, we pay 460 rubles. And since the dynamics of the futures very often repeats the dynamics of the stock itself, it is possible to hedge both the stocks and even portfolios of securities with options.

 

In addition to the function of exchange insurance, options also perform another one – they allow you to earn on the movement of the asset price in a certain direction (up or down). So, if the value of the underlying asset is 14,588 rubles, you can buy a call option (opportunity to buy) at 14,500 strike for 473 rubles. For you to be able to earn, the asset must rise above 14,500 rubles by the value of the option before the expiration date. Everything by which the asset rises above 14,973 rubles will be a profit on the option. If the growth does not take place, then the maximum loss is the value of the option. Similarly, if we buy a put option for 385 rubles at a strike of 14,500, then in order to earn money, the price of the asset must decrease below the specified strike by the value of the option, that is, to 13,730 rubles. Anything the asset falls below will be a profit.

 

Options allow you to make money on non-linear price changes, but such option designs require more experience. Knowledgeable traders say that it is not worth allocating more than 10% of the portfolio for this kind of work. So, if the asset is worth 94,050 pp., then you can buy both a call option (for the right to buy) and a put option (for the right to sell) at 95,000 strike (the right to deal at a specified price) for a week for 990 and 1940 pp. respectively. In this case, in order to earn money, the asset must either rise above the 95000 price level by the maturity date of the options (expiration) by 2930, or fall below the specified value. Therefore, it is not so important in which direction the asset will go – it is important that the movement is powerful.

It turns out that working with stock options is very diverse and goes well with building a portfolio of securities, complementing it and helping to control risks.

Binary Options

The first trading in binary options took place in 2008 in the USA with the participation of CME and AMEX. This type of option involves receiving a strictly fixed profit if the condition (growth or decrease) above/below the specified level is met and a loss in the amount of the option value if the condition is not met before the option maturity date. “Trades” in this type of options soon began to organize various “kitchens” (companies that do not list transactions on the exchange, but make “bets” on the value with their clients). And soon the SEC began to prohibit trading in such instruments, since the transactions were not displayed anywhere, and the companies – “kitchens”, of course, did not have the necessary licenses to create such financial products. And these bans were carried out not only in the United States, but also in a number of countries, such as Canada, France and Israel.

On the one hand, the idea of binary options allows you to clearly control the possible profit and loss. On the other hand, it allows the organizers of the auction to calculate the cost of the option in such a way that it would be unprofitable to buy it in the long term due to profit limitation.

Trading binary options has nothing to do with real stock options. Not a single binary option is traded on the Moscow Exchange. Another significant difference between an option and a binary option is that when working with binary options, a trader is offered to trade only them, which entails not a risk of drawdown, but the risk of losing capital. If the condition is not met, the option is completely depreciated, and the very principle of using options to control risk and replenish the portfolio becomes violated, which is extremely unfavorable for the trader.

The difference between binary options and stock options is obvious. Options are a portfolio complementary tool that helps control risk and maximize returns. But in order to use options in this way, they must be real – stock options.