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The Novice Traders Corner
Continuing Education For The Beginner
Calls and Puts
What is a call option?
A call is the right, but not the obligation, to purchase a stock or commodity at a specific price (the strike price) within a specific period of time (the last day of which is called the expiration date). The price you pay for an option is called the premium. If you buy a call option you profit if the price of the underlying security goes up.
What is a put option?
A put is the right, but not the obligation, to sell a stock or commodity at a specific price (the strike price) within a specific period of time (the last day of which is called the expiration date). The price you pay for an option is called the premium. If you buy a put option you profit if the price of the underlying security goes down.
A Look At Spreads, Straddles and Strangles
What is a spread?
In very basic forms of trading an investor usually goes long or short. If he or she is long, the investor buys the underlying stock or commodity, thinking that the price will go up. If he or she is short, the investor thinks the price of the underlying stock or commodity is going down. In basic trading, the investor takes a position on one side or the other (long or short) and hopes that the market moves in their direction. However, some traders go long and short at the same time!
How do you go long and short at the same time? By taking opposite positions in the same or related commodities at the same time. This is the basis for Spread trading. The spread is simply the difference between the two positions (long and short) taken on the same or related commodity. A simple spread might look like this:
BUY 1 SEPT SOYBEAN CONTRACT @ $22.00 SELL 1 DEC SOYBEAN CONTRACT @ $20.00 The $2.00 difference is the spread
In this example, the trader would be looking for the spread to widen: If the Sept went up to $24.00 and the Dec went up to $21.00, the spread would widen to $3.00 ($24.00 - $21.00 = $3.00). If the two positions were liquidated, the gain would be $1.00:
$3.00 New Spread - $2.00 Old Spread = $1.00 Profit
Now, multiply the spread profit of $1.00 by the number of bushels in a soybean contract (5000) and you get a $5,000.00 profit. As you can see, this spread became quite a profitable trade. Had the spread widened even further, the profit would have been higher.
What is a Straddle?
Straddle Trading involves buying and writing options on the same commodity at different strike prices. Then if you are forced to buy or sell because someone exercises the option(s) you've sold them, you can cover the deal by exercising your own options to buy or sell. A covered straddle involves buying the commodity and writing (selling) equal numbers of calls and puts at the same time. Whatever happens, you've collected your premium and have the underlying commodities to boot. The premiums can either increase the return you get on your commodities or reduce the cost of buying additional contracts if the price drops.
What is a Strangle?
A Strangle involves writing (selling) a call with a strike price above the current market price and a put with a strike price below the current market. This means you've collected your premium and neutralized your position at the same time.
We'll address a combination of the straddle and the strangle on the trader's page
There is a risk of loss in commodities, futures and options trading