Puts and calls are two types of options contracts or derivatives commonly used in the world of finance. These contracts give the owner the right, but not the obligation, to buy or sell an underlying asset, such as stocks and shares or currencies at a predetermined price within a specific time frame.
A put gives you the right to sell at a pre-determined price, while a call gives you the right to buy at a pre-determined price.
What is a derivative?
A financial derivative is a contract between two parties that derives its value from the performance of an underlying asset, such as a stock, commodity, or currency.
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Common examples of financial derivatives include options, futures, and swaps. These instruments are used to manage risk, hedge against potential losses, and speculate on future market movements.
While derivatives can be complex and carry a high degree of risk, they can also provide valuable opportunities for investors and businesses to manage their exposure to market volatility.
What is a put option?
A put option is a contract that gives the owner the right to sell an underlying asset at a predetermined price, known as the strike price, within a specific time frame. Put options are often used as a form of insurance against a decline in the value of an asset.
For example, if an investor owns a stock that has been performing well but is concerned that the market may take a turn for the worse, they may buy a put option to protect against potential losses.
How much you pay for that right to protect against losses is referred to as the premium, and is deducted from your profit on the sell date. Investors typically buy a put on a share if they expect the price to fall, but do not want to take the risk of actually short-selling the shares.
What is a call option?
Where puts give you the right to sell at a pre-determined price, a call gives you the right (but not the obligation) to buy them. So you buy a call with a certain strike price if you expect the price of the underlying share to rise above the fixed strike price, effectively getting the shares at a discount.
Call options are often used to speculate on the price of an asset increasing. If an investor believes that a stock is undervalued and will increase in value, they may buy a call option to potentially profit from the increase in price.
The price of an options contract is determined by several factors, including the price of the underlying asset, the strike price, the time until expiration, and the volatility of the asset's price. Options contracts can be bought and sold on exchanges, just like stocks and other securities.
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