Stock Options Trading: Buying and Selling Calls and Puts

For those who are learning how and where to invest money in Singapore as a beginner, it is important to know how to trade options by buying and selling calls and puts. Calls and puts are derivatives that provide the owners of these instruments the right but not the obligation to purchase or sell the underlying assets. Being able to understand and use options, will help you better understand the underlying complexities that drive the market.

The difference between options and stock

As mentioned earlier, options are a right but not an obligation. However, this right is not just a right to buy 1 stock. Instead, this is a right to buy a 100 or even a 1000 of the stock depending on what the contract size is for the option. In other words, an option can be seen as representing a bundle of stocks. As a result, when the underlying stock moves, so does the option. However, this relationship is not linear nor 1-1 and thus depend on how far the option is away from spot.

Further, an option can expire whereas a stock technically does not expire. This creates an additional dimension where we would need to consider the effect of time value when evaluating options.

The two concepts presented earlier are often described with the Greeks, i.e. delta, gamma and theta. Delta refers to how much the option will move when the stock moves. Because the relationship is not linear, the delta moves as the price moves as well. This is also known as gamma. In addition to delta and gamma, investors also have to consider theta refers to the time decay for the buyers of the option.

Why will you buy an option if you can buy a stock outright

Similar to the notion of utilizing leverage to increase returns, buy an option can have the same effect due to your right to purchase more shares than you have put up money for. As a result investors can potentially benefit from a high return to equity, when they employ an option strategy. That said, the non linear nature of market mechanics also means that volatility jumps are frequent and it is easy to be caught on the other side of the trade, leading to huge losses.

What are calls and puts

Calls: Calls are options that provides the right to purchase the underlying assets

Puts: Puts are options that provide the right to sell the underlying assets.