Question

Describe in detail the two kinds of options contracts that exist, also describe the advantages and disadvantages of each? Making sure to include an example of each with an explanation of price differentials.

Answer 1

Two types of option contracts are Call option and Put option

Call option is the right to buy a stock at a certain price at specified time in future.

Pit option is the right to sell a stock at a certain price at specified time in future.

Option buyers have this right but option sellers have the obligation to fulfill the contract if the buyer executes these options.

Other advantage being that you are able to take positions in stocks indirectly which you can't take in stocks directly due to shortage of funds.

Disadvantage being that these are complex instruments and if stock moves opposite to your desired outlook then you have to face huge losses.

Call option example.

It will have strike price say 50 and spot price is 45. So if by the end of expiry if it moves to say 54, then you will receive 54-50 = 4 . Thus you took position in stock indirectly by buying the call option

Similarly if you bought a put option, you are betting that stock price will go down. Strike price say 50. Spot price is 60. Now by the end of expiry price is 45. So you will get 50-45 = 5