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An option is a contract giving the buyer the right, but not the obligation, to buy or
sell an underlying asset at a fixed price on or before a certain date. If, over the life of the contract, the asset value decreases, the buyer can simply elect not to exercise his/her right to buy/sell the asset. There are two types of option contracts - Call options and Put options. A Call option gives the buyer the right to buy the underlying asset, while a Put option gives the buyer the right to sell the underlying asset. There are four types of participants in options markets: Buyers of calls, Sellers of calls, Buyers of puts and Sellers of puts. People usually uses option for hedging and speculation.
Option strategy can be:
• Long (buy), where you do long call in bullish condition and long put in bearish condition.
• Short (sell), where you do shot put in bullish condition and short call in bearish condition.
• Covered call, where you Long the underlying asset and short call options. This is often employed when an investor has a short-term neutral view on the asset and for this reason hold the asset long and simultaneously have a short position via the option to generate income from the option premium. For example, if you know a stock which will likely trade relatively flat in short term, then you go covered call, there will be three scenarios:
a) The stock trade flat - the option will expire worthless and you keep the premium from the option. In this case, by using the strategy you have successfully outperformed the stock by using the option.
b) The shares fall - the option expires worthless, you keep the premium, and the option outperform the stock again.
c) If shares rise above the strike price - the option is exercised, the option has underperformed the shares.
• Straddle, By engaging in a straddle transaction, buy/sell a call and put at the same strike price, the investor is taking position on the volatility of the underlying security. Going long a straddle is a bet that the underlier will be more volatile over the market prediction. Short a straddle is used when you are sure that the underlier will be less volatile.
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