Calls. If you believe the stock price will rise by the expiration date, you buy a call option contract. This gives you the right to buy the stock at the strike price. If the stock price is higher than the strike price, either buy the stock at a discount when the contract expires or buy the option and sell it immediately for a profit.
puts. If you think the stock price will fall by the expiration date, buy a put option contract. This gives you the right to sell the stock at the strike price. If the stock price drops below the strike price, you can buy shares at the market price and sell them at the strike price.
example: Company Y is trading at $20 per share on January 1, and you buy a six-month options contract with a strike price of $20 and a premium of $5 per share.
If you expect the market price of a stock to reach $25 — the strike price plus premium — or higher by the expiration date, buy a call option. Since this contract gives you the right to buy the stock at the strike price, you can either sell the contract for a profit or buy shares for less than the market value.
However, if you expect the market price of the stock to fall to $15—the strike price minus the premium—or less—by the expiration date, buy the put option. This contract gives you the right to sell shares at the strike price, meaning you can either sell your contract for a profit or buy shares at market value and sell them for more than you paid.
