A picture to understand call options and put options

What is the nature of options? I personally think it's insurance. The essence of all financial derivatives is insurance. Looking at the picture below, stocks are core assets or underlying assets. There are two types of stock options: call options and put options.

​call option

As can be seen in the figure, options transactions are divided into sellers and buyers. The seller is selling insurance, and the buyer is buying insurance. What the buyer buys is a right, that is to say, if I buy a call option, what I pay is the insurance premium, and I have to pay the insurance premium to the seller. What I get is an insurance (actually a right letter). For example, I am bullish that Apple stock will rise to $200 in the future, then I can buy a $200 call option.

If it rises to 210, if I exercise the option (sell the option) within the next 6 months, then I can earn 10 yuan per share; if it only rises to 180, it is equivalent to losing money .

So for me, I can choose to exercise the right or not, because what I bought is a right.

And the seller is a liability.

For example, if I sell call options, I think it is unlikely that the stock will rise to 200 in the next 6 months. If it exceeds 200, I will accept how much it exceeds. Then I will give you as many stocks as you want at the price of 200. What if I don't? I go to the market to buy now.

If Apple’s shares rise to 2,000, 20,000, or 200,000 shares in 6 months, the seller will have to admit it, so the seller bears unlimited risks and is responsible. If the buyer chooses to exercise the option, the seller cannot refuse for any reason, and can only cash it, unless it goes bankrupt. Therefore, for the seller of the call option, it is equivalent to selling a lottery ticket, with limited benefits but unlimited risks.

The buyer is equivalent to buying a lottery ticket. I only spend one dollar to buy the possibility that Apple will rise to more than $200 in 6 months. It doesn’t matter if I lose, the loss is not big anyway.

So I put the call option simply as a kind of insurance.

Buying and selling call options is a highly risky activity. In fact, all previous stock market crashes have been related to it, because the risk of the seller is infinite, and problems will definitely occur.

put option

The put option can simply call it a bottom line. The seller is actually selling a service, a bottom-up service; the buyer is buying this service.

From the perspective of the buyer first, if I think the future market is not good, not only will Apple not rise to 200, it may even fall to 100 or below 100. And what if I have a lot of stocks in my hand?

Then I will buy put options in the market and find someone to cover for me.

Let's say the current price is 101 and I price my option at $50. That is to say, if the stock really falls below $50, or even $1, then the other party (seller) will bear the entire selling price of my stock ($50).

Relatively speaking, put options are less likely to cause violent fluctuations in the stock market. Because the profit of the put option is limited, the risk is also limited. Why? The risk is limited because even if the price is falling, Apple will go bankrupt, that is, it will fall from 100 to 0, which is such a big loss.

The call option is different, its risk is infinite, because the stock can rise infinitely; the profit is also infinite, because it can also rise infinitely. This is the most essential difference between the two.