Changes in these assumptions may have a material impact on the backtested returns presented. General assumptions include: XYZ firm would have been able to purchase the securities recommended by the model and the markets were sufficiently liquid to permit all trading. Backtested results are calculated by the retroactive application of a model constructed on the basis of historical data and based on assumptions integral to the model which may or may not be testable and are subject to losses. The results reflect performance of a strategy not historically offered to investors and does not represent returns that any investor actually attained. Backtested performance is not an indicator of future actual results. The goal is to profit from the option when it expires 'in the money', with the stock price below the strike price.īy understanding these fundamental aspects, you will gain a solid foundation for navigating options trades and assessing potential profits.ĭisclaimer: The TipRanks Smart Score performance is based on backtested results. Traders usually buy put options when they expect the underlying stock's price to decline. Suppose you purchase a put option with a strike price of $60. Put options: Put options provide the holder the right (but not the obligation) to sell a specific number of shares at the strike price. The objective is to profit from the option when it expires 'in the money', meaning the stock price exceeds the strike price. Traders typically purchase call options when they anticipate the underlying stock's price to rise. ![]() Let's say you buy a call option with a strike price of $50. These concepts apply to both call options and put options:Ĭall options: Call options grant the holder the right (but not the obligation) to buy a specific number of shares at the strike price. Therefore, it is crucial to consider the relationship between the strike price and the stock price to assess potential profitability. For example, let's assume you purchase one contract with an option price of $3, resulting in a total investment (or risk) of $300. It is influenced by various factors, including the current stock price, time to expiration, implied volatility, and market demand.Įach options contract generally represents 100 shares. Option price: The option price, also known as the option premium, represents the cost per share that an option holder pays. Conversely, for put options, the strike price is usually set below the current stock price. For call options, traders typically choose a strike price that is above the current stock price. Strike price: The strike price is the predetermined price at which the underlying asset can be bought or sold upon exercising the option contract. Stock price: The stock price refers to the current market value of the underlying stock at the time of purchasing the option. To gain a better understanding of options trading and how to calculate potential profits, it's important to familiarize yourself with three key terms: strike price, option price, and stock price. They provide flexibility and strategic opportunities for investors and traders to capitalize on price movements and market expectations without directly owning the underlying asset. Options contracts are widely used in financial markets for various purposes, including speculation, hedging, and risk management. Out-of-the-money options have no intrinsic value. A put option is out-of-the-money if the current price of the underlying asset is higher than the strike price. Out-of-the-money (OTM): A call option is out-of-the-money if the current price of the underlying asset is lower than the strike price. At-the-money (ATM): An option is at-the-money when the current price of the underlying asset is equal to the strike price. In-the-money options have intrinsic value. A put option is in-the-money if the current price of the underlying asset is lower than the strike price. In-the-money (ITM): A call option is in-the-money if the current price of the underlying asset is higher than the strike price. Potential outcomes: The outcome of an options contract depends on whether it is in-the-money, at-the-money, or out-of-the-money.
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