Call and put options can be very confusing if you’re new to trading. They are, however, simply a way to play the market without actually owning the stock or currency. Here, we’ll explain call and put meaning in forex so that you can begin to understand how to trade options.
Call and Put Meaning in Forex
What are call options?
Call options give the holder the right to purchase a stock or other asset, such as a commodity or currency, at a predetermined price, known as the "strike price," on or before a specified date. The buyer of a call option believes that the underlying asset's price will rise by a specific date in the future, known as the "expiration date." This is one of the key things to understand about call and put’s meaning in forex.
For example, an investor may anticipate that the value of stocks or currency will rise over time. A call option allows them to buy a stock/currency at its current market value and still profit if its price increases significantly.
Call options give the buyer security for a specified price (exercise or strike price) during a specific period. These are written by the option writer, who receives the premium. The writer has to sell (or deliver) the underlying asset if they are assigned an exercise notice.
Although call options are not as widely used as straight out investing, they do provide high risk, high reward opportunities for investors willing to forego lower returns from more traditional investment tools in exchange for the possibility of higher returns. A call option is similar to a small business startup in this regard. Many startups fail and go out of business, but there is also the possibility of massive success and profit for investors. It's all in the details.
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How much is a call option worth?
When understanding call and put meaning in forex, it’s crucial to understand volatility. If an asset is more volatile, the strike price would be higher to compensate for that volatility. Volatility is a statistical measurement, meaning that it is not observable from the actual share prices of the underlying stock.
Options, like shares, have an expiration date. As a result, the contract is essentially guaranteed to buy or sell 100 shares of the underlying stock at a specific price by specific expiration date.
For example, if XYZ's stock is currently trading at $100 per share, you can buy a call option with a strike price of $100 and an expiration date of one month. If you agree today that you will pay $8.00 for this purchase, then this contract will cost you $800.00 (the cost of the $8.00/share x 100-share contract).
Note: If the underlying security price exceeds the call option's strike price, it is said to be in the money; otherwise, it is out-of-the-money. The intrinsic value of an out-of-the-money call option is determined by how far the underlying security can rise before expiration. When the strike and price of the stock are equal, it means that a call option is at the money.
What are put options?
Put options are a type of contract that gives the buyer the right to sell a security or asset but not the obligation to do so. They are most effective for a particular market that you believe will experience more downside pressure than expected.
If the stock price goes down considerably before an investor's option expires, he or she can buy the stock at the strike price (the predetermined price) and then sell it immediately or turn it into a long position.
Put options writers anticipate a decline in price. If it does, the put writer's option will be worth money. Thus, put writers receive a premium from the put buyer; if the option is exercised (the shares are sold to the put writer), then the seller keeps this premium.
If you currently hold shares in Apple, for example, and worry that the stock price continues to fall, you can buy a put option on your shares to protect yourself against a decline in value.
How much is a put option worth?
To figure out the price of a put option, multiply the put's strike price by 100 just as we did with call options, and you'll get a number called the "contract cost." You can then factor in the commission price (premium).
Note that "in the money" means the security price is less than the strike price, so you would buy shares if you exercised your contract. If the price is above the strike price, then it's out of the money. This is key to understanding call and put meaning in forex: there is no intrinsic value because it cannot be exercised without risk and thus represents no actual obligation on the part of the writer. An at-the-money option has a strike price that is the same as the current spot price.
What’s the difference between European and US call and put options?
When to exercise the option is a key difference between American and European options. American options are more convenient because you can make decisions at any point in time until expiration. With European options, you can only sell or buy options on the date of expiration.
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When should I use a call and put in forex?
Call and put options allow you to take advantage of upward and downward swings in prices. For example, if you think a stock or currency price will increase, you buy a call option. If the currency/stock price goes up to a level higher than what you originally paid for the option, then you can exercise the option at that price.
On the other hand, if you think a currency price will decline, you could buy a put option. If the currency hits a price lower than what you paid for it, then you can sell your option. Thus, call/put options are also helpful as hedges.
Still confused about call and put’s meaning in forex? Put simply, a call option can be used to speculate on the price of security going up in value. A put option can be used if you want to speculate on the cost of security going down in value. Some options are "out of the money." Those are worthless because you cannot exercise them for profit.