A stock option is a contract to buy or sell a certain number of shares of a particular stock at a set price for a specified period of time. The owner of the option has the right to compel the purchase or sale by exercising the option. The price at which the purchase or sale is made is called the “strike price,” and the date after which the option ceases to exist is called the “expiration date.” Since an option does not represent ownership of the underlying security, an option holder has no right to dividends paid on that security.
Buying Call Options
A call option gives the option owner the right (but not the obligation) to purchase a set number of shares of a particular stock for a set price for a specified period of time. Investors buy call options if they anticipate an impending increase in the price of the underlying stock. You are not entitled to any dividends paid by the company to shareholders. You will be entitled to dividends paid if you exercise your option and purchase the underlying stock.
Selling Call Options
You can sell a call option against shares of a stock that you already own. This is known as selling a “covered call.” Since you maintain ownership of the stock unless the option is exercised, you are entitled to any dividends paid on those shares. You may also sell call options against stock that you do not own, although this is considered to be among the riskiest of all investment strategies because your risk is unlimited. Since you do not actually own the stock that you’ve written the call against, you are not entitled to any dividends paid on the stock.
Buying Put Options
You can buy a put option, which gives you the right (but not the obligation) to sell stock at a set price for a specified period of time. You typically buy a put option if you anticipate an impending decrease in the price of the underlying stock. If you own the underlying stock, you are entitled to any dividends paid on the stock. If you exercise your right to sell the stock, you must deliver the stock. Since you no longer own the stock, you are no longer entitled to any dividends paid on the stock. You may buy a put option on stock you do not own. You are not entitled to any dividends paid by the underlying stock because you do not actually own the stock.
Selling Put Options
You can sell a put option. You’ll receive a premium in exchange for agreeing to purchase a set number of shares of a particular stock for a set price during a specified period of time. In this situation, you would own neither the option nor the underlying stock. You are not entitled to any dividends paid on the underlying stock. If the option is exercised, you will be compelled to purchase the required number of shares. Once you complete the purchase transaction, you will be entitled to any dividends paid by the stock.
Mike Parker is a full-time writer, publisher and independent businessman. His background includes a career as an investments broker with such NYSE member firms as Edward Jones & Company, AG Edwards & Sons and Dean Witter. He helped launch DiscoverCard as one of the company's first merchant sales reps.