Question for the smart guys

Option

In general: right to buy or sell property that is granted in exchange for an agreed upon sum. If the right is not exercised after a specified period, the option expires and the option buyer forfeits the money. Securities: securities transaction agreement tied to stocks, commodities, currencies, or stock indexes. Options are traded on many exchanges.

1. a Call Option gives its buyer the right to buy 100 shares of the underlying security at a fixed price before a specified date in the future-usually three, six, or nine months. For this right, the call option buyer pays the call option seller, called the writer, a fee called a Premium, which is forfeited if the buyer does not exercise the option before the agreed-upon date. A call buyer therefore speculates that the price of the underlying shares will rise within the specified time period. For example, a call option on 100 shares of XYZ stock may grant its buyer the right to buy those shares at $100 apiece anytime in the next three months. To buy that option, the buyer may have to pay a premium of $2 a share, or $200. If at the time of the option contract XYZ is selling for $95 a share, the option buyer will profit if XYZ's stock price rises. If XYZ shoots up to $120 a share in two months, for example, the option buyer can Exercise his or her option to buy 100 shares of the stock at $100 and then sell the shares for $120 each, keeping the difference as profit (minus the $2 premium per share). On the other hand, if XYZ drops below $95 and stays there for three months, at the end of that time the call option will expire and the call buyer will receive no return on the $2 a share investment premium of $200.

2. The opposite of a call option is a Put Option which gives its buyer the right to sell a specified number of shares of a stock at a particular price within a specified time period. Put buyers expect the price of the underlying stock to fall. Someone who thinks XYZ's stock price will fall might buy a three-month XYZ put for 100 shares at $100 apiece and pay a premium of $2. If XYZ falls to $80 a share, the put buyer can then exercise his or her right to sell 100 XYZ shares at $100. The buyer will first purchase 100 shares at $80 each and then sell them to the put option seller (writer) at $100 each, thereby making a profit of $18 a share (the $20 a share profit minus the $2 a share cost of the option premium).

In practice, most call and put options are rarely exercised. Instead, investors buy and sell options before expiration, trading on the rise and fall of premium prices. Because an option buyer must put up only a small amount of money (the premium) to control a large amount of stock, options trading provides a great deal of Leverage and can prove immensely profitable. Options traders can write either covered options, in which they own the underlying security, or far riskier naked options, for which they do not own the underlying security. Often, options traders lose many premiums on unsuccessful trades before they make a very profitable trade. More sophisticated traders combine various call and put options in Spread and Straddle positions. Their profits or losses result from the narrowing or widening of spreads between option prices.