Thursday, October 12, 2006
Definition of Call and Put options
Call or Put options are a form of contract entered between two parties - the buyer or holder of the contract, and the seller or the writer of the contract. Essentially, such contract provides the right, but not an obligation, to the owner of the contract to either buy or sell a specified quantity of an underlying security or asset at a specified price within a specified time, from or to the writer of the contract. However, such contract is an obligation to the owner. To exercise the contract, there is a strike or exercise price - the price at which the writer must either buy the underlying asset and deliver to the holder, or take delivery of the underlying asset from the holder and pay the holder, if exercised upon by the holder. Usually these contracts are written with a "built-in" trigger clause to protect the contract's writer against bottomless loss. Each of which works differently depending on the holder's intention.
Such form of financial instrument is termed as "sophisicated" investment tools to the investment bankers. Usually, these instruments are available quite exclusively to the important few of those investment private bankers. And these high-worth individuals or organization are pretty naive to fall for such easy trick that is calculated.
Frankly, I term what Mr. Buffett has termed all along for these instruments: "Weapon of destruction" for the finance and investment world. This is also alternatively known as derivatives. Derivatives comes in many different "sexy" term to entice the naive investors. In truth, it should be termed as gamble.
I will explain more on how each option (Call and Put) works individually soon.