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What Are Puts and Calls?

The Two Basic Components of an Option
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Options are one of the most critical parts of the financial markets.

They can be mysterious and somewhat technically challenging for stock traders.

But options can also be a powerful tool for most investors.

However, how exactly do options work?

Basically, options are part of a group of financial instruments called derivatives.

Warren Buffett once referred to derivatives as ‘financial weapons of mass destruction’.

However, when fully understood, they are an essential tool in every investor’s toolbox.

Two types of options – puts and calls.

A call option gives the investor the right to buy the underlying asset.  They do so for a predetermined price and within a given time period.

A put option gives the investor the right to sell the underlying asset.  Also for a predetermined price and within a given time period.

The price where the option can be acted upon (or exercised), the price where the underlying asset may be bought or sold, is called the strike price.

The expiration date is the time in which an investor needs to act.

A trader can choose to buy or sell either puts or calls.

That means there are four different types of basic trades.

Bullish traders can either buy a call or sell a put.  They do so when they assume the stock will rise in price.

Bearish traders can either sell the call or buy the put.  They do so when they assume the stock will fall in price.

So if a trader buys the November, 21st 50-strike call on DDD stock, that means he is paying for the right to buy shares of that stock between now and it’s expiration.

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