While there are various exotic-sounding variations, there are ultimately only 4 basic positions to trade in the choices market: You may either buy or sell call options, or buy or sell put options. In establishing a brand new position, options traders can either buy or sell to open. Existing positions are canceled by either selling or buying to shut.

No matter which side of the trade you are taking, you make a bet on the worth direction of the underlying asset. But the customer and seller of options stand to profit in very other ways.

Trading Call Options

A call option gives the customer, or holder, the correct to purchase the underlying asset—equivalent to a stock, currency, or commodity futures contract—at a predetermined price before the choice expires. Because the name “option” implies, the holder has the correct to purchase the asset on the agreed price—called the strike price—but not the duty.

Every option is basically a contract, or bet, between two parties. Within the case of call options, the customer is betting that the worth of the underlying asset will likely be higher on the open market than the strike price—and that it is going to exceed the strike price before the choice expires. In that case, the choice buyer should buy that asset from the choice seller on the strike price after which resell it for a profit.

The client of a call option must pay an upfront fee for the correct to make that deal. The fee, called a premium, is paid on the outset to the vendor, who’s betting the asset’s market price won’t be higher than the worth laid out in the choice. In most simple options, that premium is the profit the vendor seeks. It is usually the danger exposure, or maximum loss, of the choice buyer. The premium is predicated on a percentage of the scale of the possible trade.

Trading Put Options

A put option, however, gives the customer the correct to sell an underlying asset at a specified price on or before a certain date. On this case, the customer of the put option is basically shorting the underlying asset, betting that its market price will fall below the strike price in the choice. In that case, they should buy the asset on the lower market price after which sell it to the choice seller, who’s obligated to purchase it at the upper, agreed strike price.

Again, the put seller, or author, is taking the opposite side of the trade, betting the market price won’t fall below the worth laid out in the choice. For making this bet, the put seller receives a premium from the choice buyer.

To Open vs. to Close

There are additional terms to know when executing these 4 basic trades. The phrase “buy to open” refers to a trader buying either a put or call option that establishes a brand new position. Buying to open increases the open interest in a selected option, and increasing open interest can signal greater liquidity and point to market expectations. “Sell to shut” is when the holder of the choices (i.e., the unique buyer of the choice) closes out their call or put position by selling it for either a net profit or loss. Note that options positions will at all times expire on the expiration date for a selected contract. At that time, in-the-money options will likely be exercised and out-of-the-money options will expire worthless. There isn’t any must sell to shut if an options position is held to expiration.

A trader may “sell to open,” establishing a brand new position that is brief either a call or a put. A brief put is definitely taking a protracted position within the underlying market because put options rise in value because the underlying price declines. If you sell an option “naked” (i.e., unhedged), the choice seller (known sometimes as the author) is exposed, in theory, to unlimited risk. It is because the vendor of an option receives the premium on the time of the trade, but when a brief call position sees a rapidly rising underlying market, they’ll quickly see losses mount. “Buy to shut” means the choice author is closing out the put or call option they sold.