This is the first installment of a five part series to help the reader better understand how stock options work.  We will take a look first at definitions you need to understand.  We will then see how the purchase and sale of call and put options differ.

Options can be dangerous if not used properly.  It seems like everyone knows someone who lost a ton of money trading stock options.  They are very misunderstood by the general public and even by many amateur investors.  If used in an intelligent way they can be a profitable way to enhance your returns in your portfolio.

Most people hear the words stock options and instantly think they are too complicated for them to understand and only sophisticated people invest in stock options.  In reality stock options are pretty simple to understand.  In this first installment we will just take a look at some of the basic definitions so the rest of the series is easier to understand.

My hope is at the end of the series you will have a good understanding of how they work and won’t be afraid of using them or at least being able to converse about them with your financial advisor.

Common Definitions You Need to Know in Order to Understand Stock Options

Call Option – Purchasing a call option is the right to purchase an asset at a pre-determined price.  Selling a call options places an obligation to sell an asset at a pre-determined price.

Put Option – Purchasing a put option is the right to sell an asset at a pre-determined price.  Selling a put option places an obligation to purchase an asset at a pre-determined price.

Strike Price – The strike price is the exercise price at which the owner of a call option can purchase an asset or the owner of the put option can sell an asset.

Exercise – This is when the buyer of a call or the buyer of a put requires the seller to deliver the asset specified in the option in the case of a call option or the requirement for the seller of the put option to purchase the asset specified in the option.

Expiration Date – The expiration date is the date at which the call or put option expires.  Essentially at this date the contract is terminated.  This is the last day the buyer of the call option or put option can exercise their rights.