How does the Options market work and can you use a lifelike example of a put / call position which is relatable?
In: Economics
TL;DR : For you, as a retail investor, they work like going to Vegas and hitting the roulette table. For an investment bank they’re like going to Vegas and playing blackjack while counting cards.
Longer version: Basically a Call is putting a deposit to buy 100 shares a a certain price at a certain date. Called the strike price. If the strike is somewhat more than the current value chances are the amount you’ll have to put down as a deposit will be small, as people think it’s unlikely the stick will reach that value. This allows for potentially large gains. Say a stock is $100/share, and you buy a Call contract for the option to buy 100 shares at $110 in one month. That won’t cost much – chances of a stock shooting up10% in that timeframe is low. For math we’ll assume the Call is $1/share. You’re lucky! The stock goes to $120!!! This means you can buy them for $110 and turn around and sell them for $120. Or you can just sell the Call for $1000. In other words your Call is now worth $10/share. You just made $9 per share, or $900 profit off a $100 bet. Congrats.
OTOH if the stock ends the month at anything less than $100 your Call is literally worthless and you lose your wager.
You can also sell Calls. In this case you oblige yourself to sell shares at a set price. IOW you’re the House collecting wagers. In the scenario above you collect the $100 wager an of the stock goes up to $120 you have to cough up $1000. As a retail investor you’re normally only allowed to do this if you own the stocks you’re selling calls for, as the potential losses are huge.
Puts are the mirror of Calls. Instead of buying the right to buy at a certain price you buy the right to force sell at a certain price – you make money on this if the stocks go down in value so you can sell them for more than they’re worth.
In any of these cases – the “person” at the other end of the wager from you is most likely an enormous investment bank making their bets backed by entire buildings full of math and economics PHDs, each with years of investment experience and supported by enormously powerful custom built computer systems running code written by some of the best software engineers on earth that updates their valuations in nanoseconds based on developing news.
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