Overview

An option contract gives the holder the right to buy or sell an asset at a predetermined price before a certain date. In an options contract, there are puts and call options. A put option allows the holder to sell an asset at a specific price and a call option allows the holder to buy an asset at a specific price. Traders will buy put options when they anticipate an asset will decline in value and traders will buy call options when they anticipate an asset rise in value.

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Call Option

• Holder’s Right: The holder has the right to buy the asset at the strike price
• Profit Scenario: If the market price of the asset rises above the strike price, the holder can buy the asset at the lower strike price and sell it at the higher market price, profiting from the difference
• Example: A trader buys a call option that grants the right to buy 1 ADA at the current market price of $1. After a week ADA rises to$1.5 per ADA. The trader exercises his call option and buys 1 ADA for $1 which is$0.5 lower than the current market price, earning him a profit of $.05.

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Put Option

• Holder’s Right: The holder has the right to sell the asset at the strike price
• Profit Scenario: If the market price of the asset falls below the strike price, the holder can sell the asset at the higher strike price and buy it back at the lower market price, profiting from the difference
• Example: A trader buys a put option that grants the right to sell 1 ADA at the current market price of $1. After a week ADA drops to$0.5 per ADA. The trader exercises his put option and sells 1 ADA for $1 which is$0.5 higher than the current market price, earning him a profit of $.05.

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Comparison of Call and Put Options

• Objective:
  • Call Option: Used when expecting an increase in asset price.
  • Put Option: Used when expecting a decline in asset price.
• Holder’s Right:
  • Call Option: Right to buy.
  • Put Option: Right to sell.
• Market Conditions:
  • Call Option: Profitable in bullish markets.
  • Put Option: Profitable in bearish markets.
• Risk Management:
  • Call Option: Used to secure the future purchase price of an asset expected to increase in value.
  • Put Option: Used to hedge against potential losses in an asset.