Understanding Puts and Calls

by Charlotte Wood
(last updated April 27, 2011)

The world of investing has its own language and you need to understand that language if you have any desire to be successful as an investor. You need to master the basics and then you can move up to understanding the more complex forms of investment and learning the jargon of high roller investors. Puts and calls are a part of that investment vernacular you'll need to master before you can expand the boundaries of your investment world.

Before you can understand puts and calls you'll first need to wrap your mind around stock options. (See Understanding Stock Options.) Now that you have that concept under control, let's look at the basics of puts and calls.

When you look at the definition of an option—a security promising the purchase or sale of a share at a specified price—you've already dipped into puts and calls. A call is a security that allows a purchaser to buy a share at a specific price during a specific time and a put is just the opposite: a contract giving the rights for an investor to sell a share for a specific price during a specific time.

The benefit of puts and calls is simply the fact that they give you more wiggle room in the market. If a seller has a call option, he can use it to maximize his profit. If the market declines he can simply not buy the stock, but if the market is doing well, he can buy the stock at the agreed lower price and sell it for a profit. Either way, the investor avoids a loss.

With a put, on the other hand, the investor can profit from a decline in the market. With the market in a not-so-good way, an investor holding a put can sell his share for a higher price than the market price thus making a profit. The only extra costs associated with puts and calls are simply the fee to the option seller and a commission fee to the middle-man broker.

Put and call options give you just that: options. You have more control over your money and how you fare in the investment market. While puts and calls don't give you total financial security, they are called securities for a reason; they do make your investments more stable and they help you avoid significant investment loss. The time frames for puts and calls can range anywhere from three weeks to six months and experienced investors usually have a combination of puts and calls spanning various time frames. If you want to sophisticate your investment portfolio, definitely consider puts and calls—you could be happy with the results!

Author Bio

Charlotte Wood

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