Bill Poulos Presents: Call Options & Put Options Explained In 8 Minutes (Options For Beginners)

[Music] okay first to demonstrate how call options work I'm going to tell you a little story and by the way if calls and puts our old hat to you then you've already got a leg up so the method I'm going to teach you afterward will be even easier for you to apply with options okay here we go so Suzie's selling her house for $500,000 in a neighborhood that has a nearby parcel of land that is for sale as well they're two parties interested in the land Peter plans to develop the land into a beautiful park and bird sanctuary and here he plans to build a low-cost housing development now Sammy comes along and is interested in buying Susie's house for a cash deal but he has a problem he won't have the cash available for three months so he's of course worried that the house will be sold as someone else in the meantime so he decides to offer Suzy five thousand dollars or the option premium right now if she'll take the house off the market and give him the option this would be a call option to buy the house for five hundred thousand dollars which is referred to as the strike price anytime within the next three months which is the expiration date now if he does not elect to buy the house Suzy keeps the five thousand dollar premium and Sammy walks away from the deal if he does elected by the house or exercise the option Suzy still gets to keep the five thousand and he pays her five hundred thousand for the house now three things could happen in this story in scenario 1 Peter buys the nearby parcel of land this of course will increase the value of Susie's home to say six hundred thousand dollars in which case Sammy will be very happy to exercise his option to buy the house for five hundred thousand dollars in scenario two Harry buys the nearby parcel of land this of course will decrease the value of Susie's home to say four hundred thousand dollars in which case Sammy will not exercise his option to buy at five hundred thousand and he'll just walk away from the deal having lost only five thousand dollars then there's scenario three where neither party buys the nearby parcel of land Susie's house is still worth $500,000 and Sammy can elect to excercises option to buy the house for five hundred thousand or not and simply walk away from the deal losing only $5,000 in effect Sammy is controlling a $500,000 asset for three months for only $5,000 no matter what happens during that time the most he can lose is $5,000 Susie on the other hand is happy to take the $5,000 say she had no guarantee anyone else would buy the house at her asking price nor did she feel the nearby parcel of land would sell anytime soon here's a footnote to the story depending on the circumstances if Susie felt she was likely to attract another buyer in the near term she would have demanded more than $5,000 from Sammy to take the house off the market for three months likewise with call options the more the underlying asset is perceived to appreciate the higher the premium demanded by the market for that call option so now let's define his in trading terms and look at an actual example trade a call option is a contract between two parties to exchange a stock at a strike price by a predetermined date one party the buyer of the call has the right but not an obligation to buy the stock at the strike price by the future date well the other party the seller of the call has the obligation to sell the stock to the buyer at the strike price if the buyer exercises the option for example if a stock is trading at $50 and you think it's going to go up to $60 you might buy a $55 call option for say 20 cents if the stock rose to $60 that would allow you to buy the stock at $55 even though it's valued at $60 netting you a $4 and 80 cent profit on each share on the other hand the person that sold you the call would be obligated to sell you the stock at $55 and a loss of 4 dollars and 80 cents if the stock never rises above $55 by expiration date the call expires worthless and the call buyer is out 20 cents and the call seller keeps the 20 cents okay now let's look at output options work by revisiting Suzy and Sammy from our earlier story Sammy owns a truck worth $40,000 he's concerned that his truck might be damaged in an accident or even stolen so Sammy decides to buy a zero deductible insurance policy or a put option on the truck for full amount of $40,000 which would be the strike price from Suzy's auto insurance company Suzy charges him $1500 that would be the option premium for a one-year policy one year being the expiration date now three things could happen in this story in the first scenario Sammy's truck is not damaged or stolen during the year so Suzie keeps the $1500 premium Sammy is okay with losing the $1500 for the protection it provided him for the year in scenario two Sammy's truck is damaged in an accident requiring $10,000 in repairs he exercises his insurance policy or his put option by filing a claim in Suzie pays him ten thousand dollars for the repairs as agreed Sammy is happy he purchased protection for this possibility in the third scenario Sammy's truck is stolen he exercises his insurance policy which is his put option and files a claim but this time for the full replacement value of his truck and Suzie pays him the full amount of $40,000 to buy a new truck Sammy of course is very happy he purchased protection for this possibility in any case Suzie is happy because she sold many such insurance policies different put options to other drivers most which never file a claim or never exercised their options providing her with a net profit overall and here's a footnote to this story if Sammy had a poor driving record that's more risk to Suzie's so she would have charged him more than $1500 for the one-year insurance policy on the other hand if Sammy had an exemplary driving record Suzie could have charged him less as the risk would be lower likewise with put options the higher the perceived risk higher the premium demanded by the market let's look again at a definition and a training example a put option then is a contract between two parties to exchange a stock or an ETF at a strike price by a predetermined date one party the buyer of the put has the right but not an obligation to sell the stock at the strike price by the future date well the other party the seller of the put has the obligation to buy the stock from the buyer at the strike price if the exercises the option for example if a stock is trading at $50 and you think it's going to go down to $40 you might buy a $45 put option for say 20 cents if the stock dropped to $40 that would allow you to sell the stock at $45 even though it's valued at $40 netting you a $4 and 80 cent profit on each share on the other hand the person that sold you the put would be obligated to buy the stock from you at $45 at a loss of 4 dollars and 80 cents if the stock never drops below $45 by expiration date the point expires worthless and the put buyer is out 20 cents and the put seller keeps the 20 cents thanks for watching this video and I hope you enjoyed it for more free training go ahead and subscribe to our YouTube channel like us on Facebook and visit profits run Calm this is Bill Paulus wishing you good trading [Music] [Applause] [Music]

Channel: Profits Run

Views: 2,728,324

Rating: 4.9008842 out of 5

Keywords: Put Option, Simple, trade, stock, tutorial, market, call option, trading, put option, options for beginners, options strategies, options trading, how to trade options, calls and puts, call and put options, bill poulos, profits run

Id: EfmTWu2yn5Q

Length: 7min 56sec (476 seconds)

Published: Tue Dec 10 2013

Reddit Comments

[u/InfiniteAd5455]

power to the people power to the apes

[u/daytrader0912]

This was one of the first videos I watched when I was learning about options.

[u/Dismal_Prune]

This was a diamond dropped by someone with diamond hands!!! You are greatly appreciated man!!! Got so tired of people just saying DO RESEARCH! Most of us haven’t been to savvy with stocks until this and we just want to know the lingo everyone is throwing around.... It’s amazing because we can be told to hold daily but can’t get a detailed idea of what options were.... Again, thank you you just helped more people in the group than you ever could know!!!