Lesson Objective: Identifying the four building blocks of all option strategies
In the world of options, there are only four different possibilities of entering into an option contract:
- Buy an option to buy = Buy a call
- Buy an option to sell = Buy a put
- Sell an option to buy = Sell a call
- Sell an option to sell = Sell a put
You will see later on that all options strategies, no matter how complex, are simply a combination of the four possibilities above. For that reason, we refer to them as the Four Building Blocks of all option strategies.
In all cases, only the buyer has the right (not the obligation) to exercise his call or put. The seller on the other hand has the obligation to comply with the buyer’s decision.
To be able to hold this right, the buyer has to pay a price, the price of the option (also called “premium” as previously mentioned) at the time s/he enters into the trade. The seller receives the premium upfront.
| Buyer (a.k.a., holder of the option) | Seller (a.k.a., writer of the option) | |
| Call | Right to Buy: pays premium | Obligation to Buy: receives premium |
| Put | Right to Sell: pays premium | Obligation to Sell: receive premium |
Because it is essential that you fully comprehend the foundations of the option world, we will devote a lesson to each one of them.