How do call and put differ from each other?
Two commonly used terms used to refer to investment technologies in the stock market are call and put. A person who does not know anything about the stock market would not be familiar with these words being used in this way. However, for investors they are very important because they refer ways of making a profit buying and selling stocks. It is important for a beginner to understand the difference between the two so that he/she can benefit from the options.
Call and put are contracts that give you the right to buy or sell a specific stock at a particular time or at a time in the future. In the call option you make an agreement with a broker that you will buy stock for a price that you anticipate it will be on a certain date. The put option is dependent on the call and you make a profit if you anticipated correctly. If the price at the anticipated date is higher, you can then sell at the higher price and make a profit.
One way of explaining the difference is to take an example of how call and put operate. Suppose you make a call contract for $5 that you will buy the stock of a company for $100 a share on the last day of the month. At the time you make this agreement, the stock is selling at $95 per share. However at the end of the month the stock has risen to $110 per share and because of the call contract, you can buy it for $100. In this way you automatically make $10 because you own stocks that are worth more than you paid for them. You now have the option to sell these shares for $110 and then you do make the profit of $10. However, the broker only gets $5. There is also a risk in that the stock may go down by the anticipated date and in this case you lose your $5.
The put option of investing in stock allows you to sell stock at a specific price by a specific date as well. If the prices per share fall during this time period, you can buy them at the lower prices and sell them to a buyer for the agreed upon price and make a profit.
Although call and put are contracts, they are not binding. You do not have to follow through on them when the time arrives to do so. You can exercise the options if you will make a profit but if you are going to lose money, they you can just walk away with paying the premium. The premium is the cost of entering into the agreement with a broker.