A significant number of our users have asked us to provide a resource on options trading and related definitions of call options and put options. Here are some basics and we will follow up with further examples of Gold shares and options.
A call option gives its holder the right to purchase an asset for a specified price, called the exercise price, on or before a predetermined expiration date. For example, a November call option on Apple stock with an exercise price of $600 entitles its owner to purchase APPLE stock for a price of $600 per share at any time up to and including its expiration date in November. The holder of the call is not required to exercise the option. Only if the market value of the stock to be purchased exceeds the exercise price will it be profitable for the holder to exercise. When the market price does exceed the exercise price, the option holder may either sell the option or “call away” the asset for the exercise price and obtain a profit. Otherwise the option may be left unexercised.
If it is not exercised before the expiration date of the contract, a call option simply expires and no longer has value. The purchase price of the option is called the premium. It represents the compensation the purchaser of the call must pay for the ability to exercise the option if exercise becomes profitable. Sellers of call options, who are said to write calls receive premium income now as payment against possibility they will be required at some later date to deliver the stock in return for an exercise price lower than the market value of the asset. If the option is left to expire worthless because the exercise price remains above the market price of the asset, the (aside from transaction costs) the writer of the call clears a profit equal to the premium income derived from the sale of the option.
A put option gives the holder the right to sell an asset for a predetermined exercise price on or before an expiration date. A November put on Apple with an exercise price of $600 entitles its owner to sell Apple stock to the put writer at a price of $600 at any time prior to expiration. While profits on call options increase when the stock price increases, profits on put options increase when the stock price falls. A put will only be exercised if the exercise price is greater than the market value of the stock.
An option is described as in the money when its exercise would generate a profit for its holder and out of the money when its exercise would not be profitable. Options are at the money when the exercise price and asset price are equal.