How to Make Profits Trading in Puts & Calls

Puts and calls are types of stock options.

Stock options come in two varieties -- puts and calls. You are not purchasing stock. What you are purchasing is the right to buy or sell stock at a set price on or before a stated date. You make money by exercising the option prior to expiration at a price that is better than the market. If the option passes the expiration date unused, you lose your investment.

Things You'll Need

• Brokerage account

Instructions

Puts

1. Understand the basic principle of a put. A put allows you to sell the stock at a stated price prior to the option's expiration date. You should own the stock, on which you have a put, before purchasing the put or have access to the stock at a price lower than the current market value.

2. Purchase the put, using your knowledge of the market place and the odds of the price of the stock dropping during the course of the put, as a guideline to determining how much you will pay.

3. Sell the stock through the put before the expiration date if the market price for the stock drops and the put price is better than the current market price. If the market price does not drop, let the option expire unused. Sell the stock directly to the market through the stockbroker.

Call

1. Understand the basics of a call. A call is a stock option that allows you to purchase stock at a stated price before the option's expiration date. You need not own the stock, just be ready to buy it when the market price rises to the optimal level.

2. Use the call when the current market rises above the price listed on the call prior to expiration date. Purchase the stock through the option.

3. Sell the stock through the stock market at market value to make a profit. If the stock never increases in value above the cost of the call plus the stated value of the call, let it expire unused.

Tips & Warnings

• A stock option buyer can never lose more money than the cost of purchasing the option.

• When calculating the profit on the trade, include the initial cost of the option. This holds true as well when calculating to exercise a call. Make sure the market price is high enough to cover the call price plus the cost of the stock option.

• While stock purchases settle in three days, options settle in one day. This means for you to take advantage of your option, you need to do it by the close of the business day on which it expires. If it expires on a weekend date, settle the previous Friday.

References

• Wilmington Trust: Understanding Calls and Puts
• Forbes: Options Basics: Puts And Calls
• Getting Acquainted With Options Trading