Buying and selling options
Editorial staff, J.P. Morgan Wealth Management
Options are contracts that give the owner the right but not the obligation to buy or sell an asset at a specific strike price and date. They are financial derivatives, meaning they derive their value from an underlying asset, which is often a stock (or equity), and trading options may be a way to help reduce potential losses or amplify potential gains when an asset goes up or down in value.
Each options contract typically represents the purchase or sale of 100 shares of an underlying security. Each options contract stipulates an expiration date and a strike price for the transaction if the owner decides to exercise the option. The Options Clearing Corporation (OCC) regulates and guarantees options trades.
You can be either the buyer or seller of an options contract. There are two kinds of options contracts: puts and calls. Puts are options to sell a security, and calls are options to buy a security.
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How does options trading work?
First let’s talk about buying options.
Buying a put option gives you the right (but not the obligation) to sell an asset, for example a stock, at a predetermined price (also known as the strike price) up to the expiration date.
- You might buy a put option if you believe the price of an asset will fall below the strike price before the expiration date.
- Buying puts is often done to help prevent you from losing money on an investment or to take away some of the risk. If you choose not to exercise the option, the most you can lose is the amount you paid for the option (the “premium”).
Buying a call option gives you the right (but not obligation) to buy an asset at a strike price up to the expiration date.
- You might buy a call option if you believe the price of the asset will rise above the strike price before the expiration date. If you choose not to exercise the option, the most you can lose is the amount you paid for the premium. If you do exercise the option, your potential profit is unlimited: as high as the stock can possibly go, less the cost of the call option.
Now let’s talk about selling options.
Selling a call option commits you to sell an underlying asset to the buyer of the contract – if they decide to exercise their right – at a strike price before and up to the expiration date. If the buyer chooses not to exercise the contract, the contract expires worthless and you profit by keeping the premium they paid.
- You might sell a call if you think the price of the asset will remain below the strike price up to the expiration date, and you want to earn income from selling an option contract to a buyer who pays you a premium for the option.
- Your maximum loss is unlimited unless you have sold a covered call. Selling a covered call means you own the underlying stock, and the most you stand to lose is the difference between the value of the shares you hold and the strike price of the option less the premium you received from the option sale.
Selling a put option commits you to buy a stock from the buyer of the contract – if they decide to exercise their right – at a strike price before and up to the expiration date. If the buyer chooses not to exercise the contract, the contract expires worthless and you profit by keeping the premium they paid.
- You might sell a put if you think the price of the asset will remain above the strike price up to the expiration date, and you want to make money from the premium you receive for selling the option to the buyer.
- Your maximum loss is the difference between the strike price minus the premium received.
The bottom line
As with all investment decisions, buying and selling options comes with associated risks and involves careful thought and consideration. It’s important to ensure any options trades you engage in line up with your investment goals.
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Editorial staff, J.P. Morgan Wealth Management
