Puts and Calls
Puts and Calls are terms defining actions that traders take when they are placing trades on the stock markets — they are also known as stock options.
A Put enables a trader to sell a given number of shares in a stock for a given price. This price is called the strike price or the exercise price. The trade is given a specific time limit, in other words it has a defined expiry date and time.
A Call enables the trader to take the opposite action and buy a specific number of shares in a stock with the same parameters.
These stock options — puts and calls are traded by the person or legal entity that owns the stock in the company that is listed on the stock market. They are not traded by the listed company as this would amount to betting on its own stock and would give rise to issues of insider trading. Listed companies are more concerned with improving the value of their stock so that traders will want to trade their stock.
When a trader buys a Call option, he is basically betting that the price of the stock will rise from the time he places his trade and stay higher than the Strike Price until his trade expires. He will then gain the difference between the Strike Price and the price prevailing at the time the trade expires.
During the process, the trader never actually owns the stock he is said to be trading, he merely anticipates that the price will rise and makes a profit or loss as a result of the movement on the stock exchange.
A Put option sees the trader anticipating that the price of the stock he is interested in will fall over a specified period.
In the reverse position from Calls, the price of the stock in a Put trade must be lower than the strike price when the option expires. The profit made by the trader is the difference between the strike price and the closing stock price less the costs of the transaction which have to be paid to the trading house.
Both these stock options mean that traders can profit from the rise and fall of stock prices, but they don’t have to own the stocks to do this. Another benefit of this is that the potential loss that the trader is exposed to is limited to the price paid for the stock option. The risk is not linked to the actual losses that the stock may suffer.