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All options search strategies are comprised of some combination of the basic legs described below.
A long call can profit if the underlying asset's price increases above the strike price of the option on or before expiration. If this happens, the holder of the long call could buy the underlying asset at the lower "fixed strike price," and sell the underlying asset back into the market at the higher market price. The option itself would also increase in value as the underlying asset price moves above the strike price. This means the holder could sell the option itself at a higher price than was paid to purchase it initially.
Long calls are considered bullish because they profit if the underlying asset increases in price. Long calls involve payment of a premium to purchase the call. This premium is the only dollar risk the holder can incur. Since an underlying asset could increase in price by an unknown amount, the reward is unlimited. If the underlying asset decreases in price, the holder may sell the option at a lower price than initially paid or allow the option to expire worthless. Closing a losing position before the option expires instead of letting the option expire worthless limits the loss to the difference between the price paid and the price received when sold.
A long put can profit if the underlying asset decreases in price below the strike price of the option on or before expiration. If the underlying asset price decreases, the holder of the put could buy the underlying asset in the open market at a lower price, and then sell it at the higher fixed strike price. The option itself would also increase in value as the price of the underlying decreases below the strike price, which means the holder could sell the put at a higher price than was paid to purchase it initially.
Long puts are considered bearish and involve payment of a premium to purchase the put. This premium, however, is the only dollar risk the holder can incur. As with long calls, the reward is unlimited (at least, to a zero dollar value of the underlying asset). If the underlying asset increases in price, the holder may sell the option at a lower price than initially paid, liquidating the position and limiting the loss. Or, the holder can allow the option to expire worthless and lose the premium paid.
A short call, like the long put, can also profit if the underlying asset price decreases below the strike price of the option by the expiration date. Since a short call involves the writer selling the call, the writer receives a premium (paid by the holder to purchase the call) which obligates him or her to sell the fixed amount of the underlying asset at the fixed price to the holder if the call is exercised (assigned).
The writer of a short call is hoping that the underlying asset will decrease to a price lower than the strike price of the call. This would allow the call to expire worthless.
Short calls are considered bearish and receive payment in the form of a premium for selling the call. This premium is the only reward in this position. The risk is unlimited because the asset could increase in price to an unknown amount. If the option expires in-the-money, the option may be exercised and consequently the writer would be assigned. Assignment would mean the writer must sell the underlying asset to the holder per the terms of the option contract. To prevent assignment or to limit losses, the writer may purchase the call prior to expiration thereby closing the position.
The short put, like the long call, can profit from an increase in price of the underlying asset. This occurs when the asset is trading at a price higher than the strike price of the option. A short put involves the writer selling the put and receiving a premium which obligates him or her to buy the fixed amount of the underlying asset at a fixed price on or before a specified date from the holder if the option is exercised.
The writer of the short put is hoping that at option expiration, the underlying asset will increase to a price greater than the value of strike price.
Short puts are considered bullish. Just like the short call, the premium received for selling a put is the only reward in a short put position. The risk is unlimited (to a dollar zero value) because the asset could decrease in value to where the option could be exercised. If exercised, the writer would be assigned and have to buy the underlying asset from the holder per the terms of the options contract. As with the short call, to prevent assignment or to limit losses, the writer may purchase the put before expiration, thereby closing the position.