Technically, Options aren't investments in themselves. Rather they are a means of managing investments in stock. Generally options can be categorized as either Calls or Puts. These are contracts that allow the purchaser to buy or sell stock at a specified price at a specified time.
This is contract that allows its owner to buy a specified amount (usually 100 shares) of stock at a specific price (the strike price) at any time until the option expires on a specific date in the future.
There are three ways in which a call can be handled.
- The buyer is speculating that a given stock is going to increase in price. If the stock does rise in value, the call owner can sell the call - and depending on how long it takes for the price increase to occur - collect a profit. If the stock exceeds the strike price, the buyer can exercise the call option and buy the stock at the strike price. It is usually advantageous to sell, rather than exercise a call option.
- Covered Call - the seller of the option contract agrees to sell stock he already owns at the strike price in the event that the call is exercised. Only the option owner can decided to exercise and the call writer cannot influence that decision. In exchange for the writing the contract, the writer is paid a specified sum (the premium) upfront, and keeps that cash regardless or whether the call is exercised or not. the risk of this strategy is that the stock may undergo a severe price decline.
- Naked Call - Probably one of the most dangerous maneuvers, and appropriate for only the most experienced option traders. The writer agrees to sell stock at the strike price - without owning the stock. He is gambling that the call will expire without being exercised (expire worthless). Losses can be substantial when the stock rises sharply.
This is a contract that allows the buyer to sell a specified amount of stock at a specific price at a specific time in the future.