What is Options Trading all about Pt2

Earlier we talked about how Options allow us to participate in expensive stocks for a fraction of the price. Well, how? To find out how, we need to understand the purpose of Options.

Stocks are typically held over a long period of time, this is called investing. Like properties, you buy it and expect its value to increase in the future. Now, what if it's value does not go up in future?

Here's where Options come in. There are 2 types of Options: Call and Put Options
Call Options are purchased when the price of the stock is expected to go up in future. It gives you the right to buy the stock in future at the current price it's at.
If the stock did go up, the value of the option would also go up. The difference in price of the stock will translate into the Intrinsic value of the Option (read What is Options Trading All About Pt.1 if you're a bit lost here). This allows you to sell the Option at a nice profit! Great?

Here's the interesting part, Put Options on the other hand are purchased either as a protection in the event your stock drops in value or purchased on it's own (without the stock) if the stock is expected to drop in price. It gives you the right to sell the stock in future at the current price it's at.

Exercising the Option: Say you bought a stock at $100. But 3 months later, instead of going up, the stock dropped to $70. If you bought 10 shares that would result in a $300 loss. But if you had bought an Option with a strike price of say 115 (In the money), this allows you to sell the stock at $115, making a $50 profit from your 10 shares!

Selling the Option: What if you only bought the Option (and not the stock)? For Put Options, the intrinsic value increases when the stock drops in price (It is of value to people who bought the stock more than $115 because this give them the right to sell a $70 stock at $115. But since you did not buy the stock, you'd profit not from the stock but from the Option.)

Although Options have expiry dates, if you decide not to use the Option before it expires (sell the Option/ exercise the right to buy/sell the stock), all you can potentially lose is the price paid for the Option (called the premium).

*I'll elaborate more on Strike price, In the money, Out the money and At the money in another post!