What is an option?

An option is a financial contract that gives the buyer the right, to buy or sell the underlying stock at a predetermined price (AKA the strike price) before or at a certain date (AKA the expiration date). There are two main types of options: call options and put options.

Let's dive into the basics of options trading using Apple ($AAPL) and Microsoft ($MSFT) as simple examples.

Call Option Example

Definition: A call option gives the buyer the right, to buy a stock at a certain price within a specific period.

Example with $AAPL:

Let's say you believe that Apple's stock, currently trading at $150, will increase in the next month. You decide to buy a call option.

• Strike Price: $160
• Expiration Date: 1 month from today
• Premium: $5 per share (the cost of the option)

Scenario 1: Stock Price Goes Up

If the stock price of $AAPL rises to $170 before the expiration date:

• You have the right to buy $AAPL at $160.
• You can then sell it at the current market price of $170.
• Your profit per share is $170 (current price) - $160 (strike price) - $5 (premium) = $5.

Scenario 2: Stock Price Goes Down

If the stock price of $AAPL stays at $150 or drops:

• You don't exercise your option because it’s cheaper to buy $AAPL at the market price than at the strike price.
• You lose the premium you paid, which is $5 per share.

Put Option Example

Definition: A put option gives the buyer the right, to sell a stock at a certain price within a specific period.

Example with $MSFT:

Let's say you believe that Microsoft's stock, currently trading at $300, will decrease in the next month. You decide to buy a put option.

• Strike Price: $290
• Expiration Date: 1 month from today
• Premium: $4 per share (the cost of the option)

Scenario 1: Stock Price Goes Down

If the stock price of $MSFT falls to $270 before the expiration date:

• You have the right to sell $MSFT at $290.
• You can buy it at the current market price of $270.
• Your profit per share is $290 (strike price) - $270 (current price) - $4 (premium) = $16.

Scenario 2: Stock Price Goes Up

If the stock price of $MSFT stays at $300 or rises:

• You don’t exercise your option because it’s better to sell $MSFT at the market price.
• You lose the premium you paid, which is $4 per share.

Summary

• Call Option: Profitable if the stock price goes up. Example: Buying $AAPL call option.
• Put Option: Profitable if the stock price goes down. Example: Buying $MSFT put option.

Remember, options can be complex and carry risks. It’s important to fully understand how they work and consider consulting with a financial advisor before trading.