Even experienced investors sometimes have trouble deciding when to use a call option versus a put option.
But there are always options trading strategies they can use as guidelines. And they’re easier than you might think.
You owe it to yourself and your wealth to take a closer look at trading options as part of your well-rounded investment strategy.
While there are all sorts of advanced options strategies out there, the simplest by far is buying an option to profit from your bullish or bearish projection on the market.
If you are bullish, you buy a call.
If you are bearish, you buy a put.
It really is that simple.
Here’s exactly what that means.
What Are Puts and Calls?
A call option contract on a stock gives the holder the right, but not the obligation, to buy 100 shares of that stock at a fixed price, by a fixed date. That fixed price is called the strike price, and the date is called the expiration date. The price you pay for the option is called the premium.
The best part is that the premium is usually many times smaller than the amount needed to buy the stock itself. You “control” those 100 shares for a fraction of the cost of owning them. That gives you tremendous leverage to multiply your gains if the stock rises. And if the stock falls, all you can lose is the premium you paid for the option, which is a fraction of what you could lose buying the stock outright.
Put options contracts work the same way, but they give the holder the right to sell 100 shares of stock at a fixed price by a fixed date.
But options trading can actually serve multiple purposes. Here’s how you can get more creative in deciding to buy a put or call.
When to Use Puts and Calls
There are many ways to use options, but there are three basic themes for beginners.
First, you may want to speculate on the direction of the underlying stock, as we covered above.
Second, you may want to enhance your returns when you already own the underlying stock.
For example, to enhance your returns when you already own shares of a stock, you can create extra income by selling a call option on that same stock. This is called a “covered call.”
If you think the stock will stay the same or only move a little higher, you sell the call option, and the premium is credited to your account. If the option expires worthless because the stock did not rally, you get to keep the premium.
You can do this over and over again.
Third, you can use options as an insurance policy on a stock you already own. To protect the stock you already own, you can purchase a put option on that same stock. If the stock price falls, the option price rises. That can partially offset your loss on the stock.
Once you get the feel for these simple options strategies, you can move on to more advanced strategies. They can really leverage your investments and reduce risk even more.
Source: Money Morning