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Ok I read ONE reply to this and I am by no means an expert, but this is what I have as an understanding...

You can BUY a CALL or a PUT, but you can also SELL(write) a CALL or a PUT.
A CALL is an option to purchase shares at the strike price. A PUT is an option to sell shares at the strike price.

Most individual or novice investors would not take the worries of SELLING or writing Stock Options, which is what you are doing in your post with "...sell a put option.." However, BUYING stock options CAN give great gains with LIMITED risk by leveraging small amounts of money to buy the options.

If you BUY a CALL option w/ a strike price of 10 for 1/4 when the stock is at say $5/share then you are hoping that before the option expires the price will go UP and even better surpass your strike price. Most options are for 100 shares of the underlying stock so the actual money needed to buy that option was $25.00.
Should the stock price meet your strike price of 10 the option could be sold for say 5 (5 x 100 =$500). You will want to use ACTUAL stock option prices as I do not know mathmatically how they rise and fall with the stock, but once the stock price is in your favor and passes your strike price (IN THE MONEY as compared to OUT OF THE MONEY) the price of the stock is usually in direct sync with the profit you WOULD have had IF you shelled out $500.00 to begin with and bought 100 shares of that $5 stock. So for leveraging money you can make a profit of $500 by having $500 (Buy Stock) OR get $475 profit by using only $25.00(Buy an Option).

The LIMITED risk part comes into play if that $5 stock went to the toilet OR just plain went bancrupt. You shelled out the $25.00 up front meaning if you forgot you had the option or the company went under you are only out $25.00 PERIOD! MAX! And in most cases even if the stock went to $1/share the option would probably be worth at least a $1 or something. That is the limited risk of options, the most you can possibly lose (BUYING options mind you!) is the money you spent to get it.

This scenario was for BUYING a CALL option. If you think the stock will go down then you would want to BUY a PUT option. Everything above is the same, BUT you are making money as the stock price goes down.

If I did an OK and CORRECT translation in layman's terms (as I am one) I will explain the MAJOR RISK difference in SELLING or writing Stock Options. Please correct me on anything I may have said that was incorrect. Thanks. : )

-= Abel =-
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