Options are contracts that give the holder the right (but not the obligation) to take on a position in an underlying instrument at a previously agreed price. They are only valid for certain time periods, as determined by the terms of the contract.If you are holding a long position in Call
options and you exercise them, you will take on a long
position in the underlying.If you are holding a long position in Put
options and you exercise them, you will take on a short
position in the underlying.The actual mechanics of (Exchange Traded) Puts and Calls are similar. They have the same data fields, etc. just reward different directions of market moves. Also, more advanced option trading strategies involve selling (often referred to as ‘writing’) Put and Call options.
An example that is more granular in nature will flesh out the details and illustrate the opportunities made available to you by trading Puts / Calls.
Call Options: Long positionStrike Price: $260Expiry date: Day 37In the example the solid blue line shows the price of the Underlying instrument. This rises over time and when it exceeds the Strike Price of the Call option then exercising the option (giving instruction to convert the option into a Long
position in the underlier) will result in profit.Technically speaking, exercising the option involves receiving the underlying instrument at a price of $260 but in practice it is typical that instead of processing the trade‘long-hand’ the cash reflecting the profit ($270-$260) is just reflected in your account.Note the date at which exercising the Call options becomes advantageous is day 20. Prior to that day you would have been able to buy the underlying instrument in the open market at a price ranging from $246 to $259 rendering the option to buy them at $260 worthless. Between days 20 – 37 the price of the underlier in the open market is higher than the strike price of $260 and exercising the option would be profitable.
Put Options: Long positionStrike Price: $260Expiry date: Day 37In the below example the solid blue line again shows the price of the Underlying instrument but is this time showing bearish price action. As you are long Puts, when the price of the underlier is below the Strike Price of the option then exercising after day 20 (instructing to convert the option into a Short
position in the underlier) will generate profits. For example, on Day 37 exercising the option would see you sell at $260 and you could buy the same amount and flatten the position at the lower price of $238.
Note the date at which exercising the Call options becomes advantageous is day 20. Prior to this day you would have been able to sell the underlying instrument in the open market at a higher price than $260.While the principles behind trading options are relatively straightforward, options remain something that only the most experienced trader should consider. There are lots of nuances and minor details that need to be taken into account. Just one example is that European Options can only be exercised on Expiry Date,butAmerican Options can be exercised at any point up to Expiry. There are many more quirks associated with Options, making them something you need to approach with as much caution as interest.