CALL OPTIONS AND PUT OPTIONS
There are two kinds of options: Call Options and Put Options.
A Call Option is an option to buy a stock at a specific price on or before a certain date. In this way, Call options are like security deposits.
If, for example, you wanted to rent a certain property, and left a security deposit for it, the money would be used to insure that you could, in fact, rent that property at the price agreed upon when you returned.
If you never returned, you would give up your security deposit, but you would have no other liability. Call options usually increase in value as the value of the underlying instrument increases.
When you buy a Call option, the price you pay for it, called the option premium, secures your right to buy that certain stock at a specified price, called the strike price.
If you decide not to use the option to buy the stock, and you are not obligated to, your only cost is the option premium.
Put Options are options to sell a stock at a specific price on or before a certain date. In this way, Put options are like insurance policies.
If you buy a new car, and then buy auto insurance on the car, you pay a premium and are, hence, protected if the asset is damaged in an accident. If this happens, you can use your policy to regain the insured value of the car. In this way, the put option gains in value as the value of the underlying instrument decreases.
If all goes well and the insurance is not needed, the insurance company keeps your premium in return for taking on the risk.
With a Put Option, you can "insure" a stock by fixing a selling price.
If something happens which causes the stock price to fall, and thus, "damages" your asset, you can exercise your option and sell it at its "insured" price level.
If the price of your stock goes up, and there is no "damage," then you do not need to use the insurance, and, once again, your only cost is the premium.
This is the primary function of listed options, to allow investors ways to manage risk.
Exercising Options
People who buy options have a Right, and that is the right to Exercise.
For a Call Exercise, Call holders may buy stock at the strike price (from the Call seller).
For a Put Exercise, Put holders may sell stock at the strike price (to the Put seller).
Neither Call holders nor Put holders are obligated to buy or sell; they simply have the rights to do so, and may choose to exercise or not to exercise based upon their own logic.
Assignment of Options
When an option holder chooses to exercise an option, a process begins to find a writer who is short of the same kind of option (i.e., class, strike price and option type). Once found, that writer may be assigned.
This means that when buyers exercise, sellers may be chosen to make good on their obligations.
For a Call Assignment, Call writers are required to sell stock at the strike price to the Call holder.
For a Put Assignment, Put writers are required to buy stock at the strike price from the Put holder.
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