different rights and their sellers different obligations.
Call Option
A call option offers its holder the capability to purchase that option's
underlying stock at the designated strike price until the option's expiration
date. For example, the owner of an XYZ March 50 call has the right
to purchase XYZ for $50 on or before its expiration in March.
1. The purchaser of a call option is speculating the following:
a. That the underlying stock will increase in value
b. That the option is undervalued and will increase in value due to
changes in the pricing variables. If so, the purchaser will be able
to exercise the right to buy the underlying security from the call
seller for less than the price at which it is trading on the open
market. The purchaser will then be in a position to profit from
either selling or holding the higher-priced stock. As an alternative
to exercising the call, the holder can choose to sell the option
for a premium prior to expiration. The option's value itself
increases relative (among other things) to an increase in the
underlying security.
2. The seller, or writer, of a call is obligated (upon assignment) to sell
the underlying stock to the call purchaser. As opposed to the purchaser,
the seller of a call option is speculating the following:
a. That the underlying stock price will stay the same price or
decrease in value
b. That the option is overvalued and will decrease in value due to
changes in the pricing variables. Under such conditions, the
option itself would decrease in value and/or expire as worthless.
The seller then relies on not having to fulfill the contractual
obligation to the buyer, thereby profiting from the sale of the
option. If the option holder does exercise his or her right to buy
the underlying security for the specified strike price, however,
then the seller must sell 100 shares of XYZ for $50 a share for
each call exercised. The party that is exercising the call does not
care whether the seller sells XYZ holdings that he or she already
owns, goes out to the market to purchase those shares, or borrows
the shares from a broker.
Put Option
The owner of a put option has the right to sell that option's underlying
stock for the designated strike price until the option's expiration date. For
example, the owner ofaXYZ March 40 put has the right to sell XYZ for
$40 on or before its March expiration.
1. The purchaser of a put option is speculating the following:
a. That the underlying asset will decrease in value
b. That the option is undervalued and will increase in value due to
changes in the pricing variables. If so, he or she will then be able
to exercise his or her option-and the put seller will have to buy
the stock from the put buyer at a higher price than the current
trading pricein the open marketplace. As a result of a decline in
the price ofthe underlying securit~ the right to sell the underlying
security at a price higher than its current trading price would
become more valuable. The put holder is then able to simply sell
the option at a premium of the original purchase price, thereby
profiting from the stock's decline.
2. The seller, or writer, of a put is obligated (upon assignment) to purchase
the underlying stock from the put purchaser. As opposed to the
purchaser, the seller of a put option is speculating the following:
a. That the underlying stock price will stay at the same price or
increase in value
b. That the option is overvalued and will decrease in value due to
changes in the pricing variables
If the put option were to decline in value due to an increase in the
price of the underlying security and/or a decrease in volatility, the put
seller could either purchase the put for less than he or she sold it or let it
expire as worthless and collect the entire premium received for the sale.
The seller (writer) of a put is obligated to buy the underlying stock from
the put purchaser, regardless ofthe price at whiwhich the underlying stock is
currently trading in the open marketplace.
Read More: The Two Types of Stock Options
