While there can be a lot of reward in trading or investing in stocks, there is also a lot of risk, because the price of your share of stock can go down.
How can you protect yourself against this risk? Take a look at this story.
Let's say that you buy a stock of XYZ Company at $10 per share.
You want to keep this stock for long term investment, with the possibility of selling it at a good price in the future; maybe even as high as $15 in the future (maybe 3 years from now).
However, you're also worried about the risk that your XYZ $10 stock may go down in price, like maybe to $5.
If this happens, you will have lost half of your money.
So, what do you do? You enter into an agreement with ABC Company (different from XYZ), which promises that if even if the price of your XYZ $10 stock goes down in the stock market to $5 or even zero, ABC will guarantee that they will be willing to buy your stock at the same $10 that you bought your stock for (and this is only if you choose to sell the stock to them).
This way, you are protected from "downside" risk if your stock crashes, but you are still able to get any possible "upside" reward if your stock goes up in price.
In order to formalize this agreement, ABC Company issues you a piece of paper as proof that your agreement exists.
What is this piece of paper called? It's called an "option" or a "stock option".
Why's it called an 'option'? Because you, the holder of the option, now have the "choice" or "option" to sell your stock to ABC Company at the agreed $10 price if you choose to use or "exercise" the option.
While you are the holder of the option, ABC Company is the one giving you that choice, so it is called the "issuer" of the option.
The option discussed above, in which you have the choice to sell a stock to ABC Company at a set price even if your stock price goes down is more specifically called a put option.
There's also another option called a "call" option, which, in a way, is the "opposite" of a put option.
Instead of having the choice to sell a stock at a certain price even if the price goes down, you have the choice to buy a stock at a certain price even if the price goes up.
Since the concept of a call option is just as extensive as a put option, it will best be covered in its own unique article.
Note that in real life, you normally do not buy options directly from the issuing company (in our example above, it was ABC Company).
Instead, you would buy or sell options from an options "exchange" which is similar to a stock exchange but where options are traded instead of stocks.
How can you protect yourself against this risk? Take a look at this story.
Let's say that you buy a stock of XYZ Company at $10 per share.
You want to keep this stock for long term investment, with the possibility of selling it at a good price in the future; maybe even as high as $15 in the future (maybe 3 years from now).
However, you're also worried about the risk that your XYZ $10 stock may go down in price, like maybe to $5.
If this happens, you will have lost half of your money.
So, what do you do? You enter into an agreement with ABC Company (different from XYZ), which promises that if even if the price of your XYZ $10 stock goes down in the stock market to $5 or even zero, ABC will guarantee that they will be willing to buy your stock at the same $10 that you bought your stock for (and this is only if you choose to sell the stock to them).
This way, you are protected from "downside" risk if your stock crashes, but you are still able to get any possible "upside" reward if your stock goes up in price.
In order to formalize this agreement, ABC Company issues you a piece of paper as proof that your agreement exists.
What is this piece of paper called? It's called an "option" or a "stock option".
Why's it called an 'option'? Because you, the holder of the option, now have the "choice" or "option" to sell your stock to ABC Company at the agreed $10 price if you choose to use or "exercise" the option.
While you are the holder of the option, ABC Company is the one giving you that choice, so it is called the "issuer" of the option.
The option discussed above, in which you have the choice to sell a stock to ABC Company at a set price even if your stock price goes down is more specifically called a put option.
There's also another option called a "call" option, which, in a way, is the "opposite" of a put option.
Instead of having the choice to sell a stock at a certain price even if the price goes down, you have the choice to buy a stock at a certain price even if the price goes up.
Since the concept of a call option is just as extensive as a put option, it will best be covered in its own unique article.
Note that in real life, you normally do not buy options directly from the issuing company (in our example above, it was ABC Company).
Instead, you would buy or sell options from an options "exchange" which is similar to a stock exchange but where options are traded instead of stocks.
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