Calls may be the most well-known type of option. They offer the chance to purchase shares of a stock (usually 100 at a time) at a price that is, hopefully, lower than the price the stock is trading at (when the option expires).<\/p>\n\n\n\n
This means the best time to buy a call option would be when you expect the price of the stock to go up before the expiry date.<\/p>\n\n\n\n
There are four potential outcomes once you purchase your call option.<\/p>\n\n\n\n
- \n
- Profit<\/li>\n\n\n\n
- Breakeven<\/li>\n\n\n\n
- Partial loss<\/li>\n\n\n\n
- Total loss<\/li>\n<\/ol>\n\n\n\n
We\u2019ll start with breakeven<\/b>, since that acts as the baseline for the rest of the outcomes. Essentially, breakeven is the point where the money you put in is the same as the money that comes out \u2014 you\u2019re left with net zero on your investment.<\/p>\n\n\n\n
Let\u2019s look at a hypothetical scenario of an option approaching its expiration date:<\/p>\n\n\n\n
You buy a call option for 100 shares of your favorite stock.<\/b><\/p>\n\n\n\n
Strike price: $10\/share<\/b><\/p>\n\n\n\n
Option cost (premium): $100<\/b><\/p>\n\n\n\n
The stock price then rises to $11 \u2014 past your $10 strike price!<\/p>\n\n\n\n
As exciting as the news is, you haven\u2019t quite reached the profit point yet. Why? Because $11 is your breakeven point. You made $100 ($1 for each of your $100 shares), but you spent<\/i> $100 to buy the option in the first place. That leaves you with net zero. Not the best, not the worst.<\/p>\n\n\n\n
![\"\"](\"https:\/\/www.etoro.com\/wp-content\/uploads\/2022\/11\/calls-equation.png\")
<\/figure>\n\n\n\nOf course, it\u2019s rare for a stock to land exactly<\/i> on your breakeven point at the time your option expires. That leads us to the other three scenarios.<\/p>\n\n\n\n
Let\u2019s continue with the most favorable outcome: profit<\/b>.
In order to profit off of a call, the price of the underlying stock needs to move above<\/i> your breakeven point.<\/p>\n\n\n\nFor every $1 above the breakeven point the stock moves, in theory, you\u2019d get $1 for every share in profit! If we go back to our previous scenario, that means a $12 stock makes you $100. If it goes up to $15, you\u2019ll make $400. At $21, you\u2019d make a whopping $1,000! You can see how small changes in share price can add up to large amounts of value \u2014 once you pass that profit point.<\/p>\n\n\n\n
But what about the other side? Well, if the stock never reaches your strike price, you lose the whole investment \u2014 that\u2019s considered a total loss<\/b>. Bummer. But, you can rest easy knowing that in almost all situations, your initial investment is usually the most<\/i> you\u2019ll lose*. So breathe a sigh of relief, rethink your strategy, and see what investment you might want to make next.<\/p>\n\n\n\n
And what about the space between your strike price and your breakeven point? In our previous scenario, that would be the price between $10 and $11 \u2014 let\u2019s say it lands on $10.50. In this case, you\u2019d experience a partial loss<\/b>. You made $50, but you originally put in $100 \u2014 so you\u2019d still be losing $50, overall. Again, not great, but not nearly as bad as what you would have lost, had you shelled out thousands of dollars on 100 shares of stock.<\/p>\n\n\n\n
![\"\"](\"https:\/\/www.etoro.com\/wp-content\/uploads\/2022\/10\/unnamed.gif\")
<\/figure>\n\n\n\nYou might also hear the terms \u201cin the money\u201d or \u201cout of the money\u201d when referring to options and profitability. Put simply, \u201cin the money\u201d means that the stock price has passed an the strike price \u2014 meaning that you are in partial loss, breakeven, or profit territory. Out of the money means the stock price has not met the strike and you have had a total loss at expiration.<\/p>\n\n\n\n
What are puts?<\/h2>\n\n\n\n
Puts work on the other end of the spectrum. When you buy a put, you\u2019re reserving the right to sell<\/i> shares at, hopefully, a higher <\/i>price than they are trading at (when the option expires).<\/p>\n\n\n\n
There are two main times that you might want to buy a put. The first is when you expect the price of the stock to go down<\/i>. The second would be as a hedge \u2014 if you invest in a lot of stock, but aren\u2019t confident that it\u2019s going to go up, you could buy a put as a way to lower your risk, since you\u2019ll make some money back if the price drops enough.<\/p>\n\n\n\n
Just like calls, puts have four outcomes:<\/p>\n\n\n\n
- \n
- Profit<\/li>\n\n\n\n
- Breakeven<\/li>\n\n\n\n
- Partial loss<\/li>\n\n\n\n
- Total loss<\/li>\n<\/ol>\n\n\n\n
But in this case, the profit<\/b> begins when the stock goes below<\/i> your breakeven point, rather than above it at expiration.<\/p>\n\n\n\n
![\"\"](\"https:\/\/www.etoro.com\/wp-content\/uploads\/2022\/11\/puts-equation.png\")
<\/figure>\n\n\n\nLet\u2019s go back to our previous example, except, this time, you think the stock price is going to drop<\/i> to $10:<\/p>\n\n\n\n
You buy a put option for 100 shares of your favorite stock.<\/b><\/p>\n\n\n\n
Strike price: $10\/share<\/b><\/p>\n\n\n\n
Option cost (premium): $100<\/b><\/p>\n\n\n\n
Let\u2019s say the stock then drops to $9. You would make $100 ($1 for each of your $100 shares), but you spent $100 on the put in the first place, once again putting you at net zero. Again \u2014 not great, not bad, just okay.<\/p>\n\n\n\n
Now, let\u2019s say that stock dropped to $8. At this point, you\u2019ve made $200 \u2014 minus the original $100 cost \u2014 meaning you\u2019ve made $100 profit<\/b>. Sweet!<\/p>\n\n\n\n
At $7, that grows to $200 of profit. At $1, you\u2019d make $800 in profit. The lower the stock goes, the more money you would make \u2014 and how many other assets is that true for? (Hint: Not a lot.)<\/p>\n\n\n\n
That means that between $9 and $10 puts you at the partial loss<\/b> scenario, and anything above<\/i> $10 will create a total loss<\/b> situation. But just like a call, this total loss is (usually) limited to your original investment in the option* \u2014 your $100 \u2014 because you can simply choose to let the option expire.<\/p>\n\n\n\n
![\"\"](\"https:\/\/www.etoro.com\/wp-content\/uploads\/2022\/10\/put-options-gif.gif\")
<\/figure>\n\n\n\nFor a put, \u201cin the money\u201d and \u201cout of the money\u201d mean the same thing as they do for a call. If you\u2019re \u201cin the money,\u201d you\u2019ve passed your strike price (partial loss, breakeven, or profit); if you\u2019re \u201cout of the money,\u201d you\u2019ve had a total loss.<\/p>\n\n\n\n
Conclusion<\/h2>\n\n\n\n
Different options can help you build out your portfolio in different ways, but all of them require some kind of opinion about the market and some hands-on activity. Not sure if options trading is right for you? Check out our article<\/a> on the subject. Or, explore options on eToro Options<\/a> today.<\/p>\n\n\n\n
*There are certain edge cases in which you may be exposed to greater loss than your initial investment. Although these instances are rare, they can occur.<\/p>\n\n\n\n
Options are complex products, involve risk and are not appropriate for all investors.\u00a0 You may lose all your invested capital.\u00a0 Please review<\/i> Characteristics and Risks of Standardized Options<\/i><\/a> prior to engaging in options trading.<\/i><\/p>\n\n\n\n
eToro Options offers listed US equity options trading via eToro USA Securities Inc., which is registered with the Securities and Exchange Commission and a FINRA member. Visit our <\/i>Disclosure Library<\/i><\/a> for additional important disclosures including our <\/i>Customer Relationship Summary<\/i><\/a> and <\/i>Privacy Policy<\/i><\/a>. <\/i>FINRA Brokercheck<\/i><\/a>\u00a9 2023<\/i><\/p>\n\n\n\n