Originally posted by: arcas
Honestly, unless you're a seasoned investor, I'd recommend steering clear of options trading.
The book <i>Options as a Strategic Investment</i> is good if you want to see how options work and how they can fit into an overall investment plan. It's a little dry at times but it's good info.
Basically a call is a contract that allows the owner of the call to buy the indicated stock at the indicated strike price. You buy a call when you're bullish on the short term outlook of a stock. Your downside potential is only your initial purchase price. If you buy 100 calls with a strike price of $65 for $3/call, the most you can lose is $300 (which will happen if the stock never goes abote $65).
A call writer/seller is indicating that he/she is willing to sell the indicated stock at the indicated price. Let's say you buy FOO Corp at $30/share and you're willing to sell at $33 (10% profit). You can write covered calls for that number of shares at a strike price of $33. If someone buys those calls and the stock never reaches $33, you keep your shares and you keep the profit made from selling the calls, too. If the stock goes to $65, you only get $33/share. That's fine, though, because you indicated you were willing to sell at $33 anyway (no different than if you'd put in a limit sell order with the added benefit that you got paid for the calls themselves). You can also write an uncovered call which means you don't already own those shares. In this case, your downside risk is unlimited since you'll have to go out and buy those shares at whatever price they're at if/when the buyer exercises the options.
A put is a contract that allows the holder to sell (or "put") the indicated stock to the contract writer at the indicated price. You buy a put when you're bearish on a stock. If I think FOO corp is going to drop significantly in the short term, I might buy some puts, wait for the price to drop and then exercise the option. Like call buyers, the most a put buyer can lose is the initial contract price. Contrast this with shorting a stock where your downside potential is unlimited.
The put seller (or writer) is saying "I'm willing to let you sell this stock to me at this price". In effect, they're saying that they're convinced that the stock is going to go up and thus the options will never get exercised.
So basically:
Call buyer: bullish on the stock
Call writer: bearish on the stock
Put buyer: bearish on the stock
Put writer: bullish on the stock
There are lots of ways you can use both calls and puts to hedge your bets to come out ahead in most cases but like I said, until you're a seasoned investor, I'd recommend staying away from options.
Edit: doh. looks like there were some more responses while I was writing this. I didn't realize this was for a class and not for personal investment.
