An option in it's simplest form is a contract that provides the right (but not the obligation) to buy or sell an asset (often a stock or an ETF) at a specific, agreed upon price within a certain time period. That specific agreed upon price is called the "strike" price, and that time period is marked by an "expiration" date. When the options buyer buys or sells the underlying asset per the options contract terms, it's called "exercising" the option.
A contract that provides the right to
buy an asset is a
call option. A contract that provides the right to
sell an asset is a
put option. For the right, but not the obligation, to exercise the option, the buyer of the option pays a fee to the option seller (fee is called "premium"). Each contract represents a right to buy/sell 100 shares of the underlying asset, so someone would need to multiply the shown premium by 100 for the cost of the contract.
Every contract has two parties, so you can buy or sell both a call option or a put option, leading to 4 basic option actions (buy call, sell call, buy put, sell put).
In short, to profit:
Call buyer wants the asset price to rise
Call seller wants the asset price to drop
Put buyer wants the asset price to drop
Put seller wants the asset price to rise
Example 1 (Call): Say you bought a
call for a stock with a strike price of $10/share for a premium of $1, if the price of the stock rises to $15/share in the market during the time period, you have the
right to buy the stock
from the option seller for $10, meaning you have a $15-$10=$5 profit/share. Since each contract represents 100 shares, your profit is $5/share*100 shares = $500. Keep in mind you paid a premium to the seller to buy the call contract in the first place, so the initial cost is $1 * 100 shares = $100. Your total profit would be $500-$100 = $400 in this case. The greater the increase in stock price, the greater the profit for the call buyer.
If you bought a call, and the stock price doesn't go up to the strike price by call expiration, the call is "out-of-money" and will expire worthless.
So here, if you're the call buyer, when price of stock goes up, you may profit. If you're the call seller, when price of stock goes up, you lose money.
Example 2 (Put): Say you bought a
put for a stock with a strike price of $20/share for a premium of $2. If the price of the stock decreases to $16/share in the market during the time period, you have the right to sell the stock
to the option seller for $20. But market only values the stock at $16/share, so you have $20-$16=$4 profit/share. Once again, each contract represents 100 shares, so your profit is $4/share * 100 shares = $400. Keep in mind you paid a premium to the seller to buy the put contract, so the initial cost is $2 * 100 shares = $200. Your total profit would be $400-$200 = $200 in this case. The greater the decrease in stock price, the greater the profit for the put buyer.
If you bought the put, and the stock price doesn't go down to strike price by put expiration, the put is "out-of-money" and will expire worthless.
So here, if you're the put buyer, when price of stock goes down, you may profit. If you're the put seller, when price of stock goes down, you lose money.
Premium is determined by a bunch of different market parameters, so the premium itself will change for the same call/put option over time.
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Sounds like short selling. Please correct me if I'm wrong.
Short selling is often used to describe betting on the market going down in general, but it technically only specifically refers to the action of
selling an option, doesn't matter whether someone is selling a call (bearish, wants to see the market go down) or selling a put (bullish, wants to see the market go up). See above examples.