There are two types of Options: Calls and Puts.

There are numerous sources online that give detail information about Calls and Puts, but most of them are very confusing. I know I was confused when I was trying to understand “Options”. So, I am going to give you guys a newbie version of Call and Put Option.

First, here are the basics on Options:

1. The smallest unit of “Options” is 1 contract. The number of contracts you buy or sell must be a whole number. For example, you can’t sell 8.5 contract.

2. 1 contract = 100 shares. So, 10 contracts = 1000 shares.

3. Options expire on the third Friday of the month. Well, technically, they expire on the third Saturday, but you have until Friday to open or close positions.

Call Option: It is an option to buy a stock at a predetermined price called the “Strike Price” by a predetermined date called the “Expiry date”.

For Example: Bank of America stocks are selling for $15.00. Say a buyer bought a Call Option of Bank of America (BAC) with a strike price of $16 expiring Jan 15th 2010. The buyer has to pay some amount, known as the “Premium” to buy that call option. In this case, it is about $0.25 per share. So, if you buy 10 contracts (1000 shares) of this call option, you will be paying $250 plus the broker commission.

If the stock price of BAC reaches $16.01 (or more) on or before the expiration date, that means you are “in the money” and you have the option to “exercise” your option to buy 1000 shares of BAC at $16.00. But, people usually just sell the contract or “close the position”. If the option is in the money, the price of “Premium” would increase and you make profit by selling that contract back in the market.

So, when you buy a Call Option you are assuming a “long” position in a stock i.e. you want the price of the stock to go up.
If you sell a Call Option, also called a “covered call”, you are assuming a “short” position in a stock i.e. you want the price to go down.

Confused yet?

Say, the price only reaches $15.90 by the expiration date. This means your Call Option is “out of the money” and it will expire worthless if you don’t close your position before the expiration date. Of course, the price of “Premium” would decrease and you lose money. If the Option expires worthless, you only lose the premium you paid.

Put Option: This is exactly opposite of Call Option. It is an option to sell a stock at a predetermined price called the “Strike Price” by a predetermined date called the “Expiry date”.

For Example: Bank of America stocks are selling for $15.00. Say a buyer bought a Put option of Bank of America (BAC) with a strike price of $14.00 expiring Jan 15th 2010. The buyer has to pay the “Premium” to buy that Put option. In this case, it is about $0.23 per share. So, if you buy 10 contracts (1000 shares) of this call option, you will be paying $230 plus the broker commission.

If the stock price of BAC reaches $13.99(or less) on or before the expiration date, that means you are “in the money” and you have the option to “exercise” your option to sell 1000 shares of BAC at $14.00. If the price is more than $14.00 then you are “out of the money”.

Buying a Put Option is like buying an insurance for your stocks. In the above example, if the stock price goes to $13 or even lower, you can still sell your shares at $14.

More facts about Options:

1. The closer you get to the strike price, the more expensive the Premium.

2. Only about 17 % of the Options are exercised. Most traders just sell or buy the contracts to close their position before the expiration date.

3. Options are risky and unless you understand what you are doing, you should stay away from them.

4. You are an idiot if you don’t try and learn how to trade Options.

Usually brokers charge, normal trading commission plus extra amount per contract to trade Options. That amount is usually ranges from $1 to $2 per contract. For example: To buy an Option through Sharebuilder, the price is $9.99 + 1.50 per contract. For 10 contract, you pay 9.99+15=$24.99.

I recommend Zecco.com (aff.) to buy Options because, the price per contract is only $0.50. For 10 contracts you will pay 4.50 + 5 = $9.5 at Zecco compared to $24.99 at Sharebuilder.

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