What are options and spreads? An option is basically a contract between two parties and, as in any contract, has a buying party and a selling party. Depending on which party it is, it will have some rights or have to assume some responsibilities.
Options are derivatives, because they derive from an initial or underlying product, which can be stocks, indices, futures, currencies, etc.
When you buy an option, you are acquiring a right, while the opposite party of the contract, to which you sell the option, is acquiring an obligation. The buyer, when acquiring this right, will be obliged to pay, and the seller, when acquiring the obligation, will receive a charge (premium, credit).
There are only 2 types of options: call and put
If you buy a call option (long call) you are buying the right to buy 100 shares at a specified price (strike or exercise price in English) on a specified date (expiration date) and the opposing party, the seller of the call option (short call), is buying the obligation to sell those shares at the specified price on the specified date.
Let’s see an example to be easier to understand. When a person goes to buy a house, they usually make a down payment and sign a promissory contract so that the buyer agrees to buy the house in a period, for example, three months from now. After 3 months, the buyer makes the rest of the payment and acquires the house, and if it is returned, the seller keeps the down payment.
Well, this is an example of a call option: there is a contract and the buyer of the contract (who wants to buy the house) is buying the right to buy that house in 3 months for the agreed price (exercise price), while the seller of the house, also seller of the contract, agrees to sell the house for the price fixed in those 3 months.
The put options are similar, but opposite. If you purchase a put option (Long Put) you are purchasing the right to sell 100 shares at a specified price (strike price) on a specified date (expiration date), and the selling party (Put Short), you purchase the obligation to buy the shares at the specified price on the specified date.
We can also find a daily example: house insurance. We assume you take out an insurance policy that guarantees a value of EUR 100,000 in case of fire. Here you are buying a Put option (the value of the annual fee), where you acquire the right to sell your house for $ 100,000 during the year, while the insurance company, which sells the Put option, undertakes to buy the house at that price during the current year, until the next renewal of the contract.
Making a summary:
The buyer of the option acquires the right (to pay) and the seller of the option has the obligation (to receive money from him)
There are 2 types of options: call and out, therefore 4 types of basic operations:
Long Call: the right to buy at the exercise price on the expiration date (or any time for US options Let’s see ….)
Short Call: obligation to sell at the exercise price on the expiration date (or, in case it is assigned. see also …)
Long Put: right to sell at the exercise price on the due date
Short Put: obligation to buy at the exercise price on the due date
Options operations are simply combinations of the 4 basic transactions among themselves and/or adding the purchase or sale of shares.
Depending on the option structure, the choice of exercise price and the expiration date of each option, we can create various strategies for:
optimize a trend (up, down or sideways)
speculative, or more conservative, strategies
Examples of spreads transactions would be: Straddle, Strangle, Covered Call, Trade Necklace, Call Calendar, Bull Put, among others.
The options are among the types of assets with the greatest risk. Before starting to invest and make operations with options, the first step is to know the risks associated with them.