There are two main types of option contracts: call options and put options. Both types of options give the holder the right, but not the obligation, to buy (in the case of a call option) or sell (in the case of a put option) an underlying asset at a predetermined price (called the strike price) on or before a specified date (called the expiration date).
## Call Options
Call options are contracts that give buyers the right, but not the obligation, to buy the underlying asset at the strike price on or before the expiration date. Call options are typically used to profit from an expected increase in the price of the underlying asset or as a hedge against a short position in the underlying asset.
The buyer of a call option pays a premium to the seller of the option. The seller of a call option is obligated to sell the underlying asset to the buyer if the buyer chooses to exercise the option. The seller of the option receives the premium paid by the buyer, regardless of whether the option is exercised or not.
For example, suppose you buy a call option on a stock with a strike price of $50 and an expiration date of 3 months from now for a premium of $2. If the stock price rises to $60 before the expiration date, you can exercise your call option and buy the stock for $50, then immediately sell the stock on the open market for $60, making a profit of $8 per share.
## Put Options
Put options are contracts that give buyers the right, but not the obligation, to sell the underlying asset at the strike price on or before the expiration date. Put options are typically used to profit from an expected decrease in the price of the underlying asset or as a hedge against a long position in the underlying asset.
The buyer of a put option pays a premium to the seller of the option. The seller of a put option is obligated to buy the underlying asset from the buyer if the buyer chooses to exercise the option. The seller of the option receives the premium paid by the buyer, regardless of whether the option is exercised or not.
For example, suppose you buy a put option on a stock with a strike price of $50 and an expiration date of 3 months from now for a premium of $2. If the stock price falls to $40 before the expiration date, you can exercise your put option and sell the stock for $50, then immediately buy the stock back on the open market for $40, making a profit of $8 per share.
In summary, call options give the holder the right to buy an underlying asset while put options give the holder the right to sell an underlying asset. Both types of options have their own unique risks and rewards, and are often used by investors to manage risk or to take advantage of market opportunities.