Simple Does It: Puts and Calls

Simple Does It: Puts and Calls

There are some pairings that just go together. One would just not be the same without the other. Mickey and Minnie. Peanut butter and jelly. Captain and Tenille. Puts and calls. What? (Insert that neat little record-screeching sound they play in a movie when all activity comes to a halt here.) Okay, so they might not be the first things that come to mind when famous word pairings are mentioned, but in the world of investing, puts and calls definitely go together like peas and carrots.

Options, Options, Options

First, in order to understand calls and puts, you have to know that both are what's considered an option in the investing world. Just like it's nice to go to your closet in the morning and see some outfit and clothing options, the investing world also likes to have options, and basically, that's what puts and calls are. A few well-chosen, timeless accessories can bring an added flexibility to a wardrobe; puts and calls do the same thing for investing in that they bring flexibility to the market.

In short, puts and calls give a buyer or seller the option to buy or sell if they so choose. But there is no obligation associated with them, so the buyer or seller does not have to buy or sell if, in fact, they don't want to.

To Put Or To Call, That Is The Question

When I think of a call, invariably what comes to mind involves a phone. Or Blondie's iconic hit. However, in terms of all things investing, a call is a type of option and contract that lets someone purchase a certain stock at a certain price within a certain period of time.

Say an investor is eyeing a pretty hot, rising-price stock. Tempting, yes, but the investor also wants to avoid losing money on the stock. So the investor uses a call option and watches the market, and from then can decide whether to buy (if the investor thinks the stock will continue to rise and maybe they can buy and then sell their shares for profit) or not (the stock looks as shaky as a newborn fawn and the potential for a major loss seems imminent).

On the flipside of a call is a put, which is pretty much a call's exact opposite. A put, investo-speak, is a contract that lets someone holding a stock sell that stock at a specific price and within a specific timeframe.

Whereas an investor might look at obtaining a call option for stocks that are on the rise, an investor might look into the put option for stocks that are expected to fall. Even if a stock's price does indeed decline, the price on the investor's put option remains the same, thus enabling the investor the potential to sell the stock at that put's price and turn a profit.

The main thing to remember about puts and calls is that they are both merely options and not obligations to sell or buy. If the market does not react the way you as an investor think it will (it falls instead of rises, for example), then the only loss you're really going to feel is the money it took to buy that put or call option.

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