Put Options and Future and Forward Contracts

1. What is a call and a put?

A Call option represents the right (but not the requirement) to purchase a set number of shares of stock at a pre-determined 'strike price' before the option reaches its expiration date. A call option is purchased in hopes that the underlying stock price will rise well above the strike price, at which point you may choose to exercise the option. Exercising a call option is the financial equivalent of simultaneously purchasing the shares at the strike price and immediately selling them at the now higher market price.

A Put option represents the right (but not the requirement) to sell a set number of shares of stock (which you do not yet own) at a pre-determined 'strike price' before the option reaches its expiration date. A put option is purchased in hopes that the underlying stock price will drop well below the strike price, at which point you may choose to exercise the option.

2. What are futures and forwards?

A futures contract is a formal commitment to purchase a specified sum of a specific commodity on a designated date. Futures contracts have historically been used by industries using said commodities as inputs. For example, a large food processor may purchase futures in corn or other grain. Industrial concerns may acquire futures contracts in oil, copper, natural gas or other materials. In these cases, the purpose of the futures contract is to protect the firm from an increase in price of the raw materials it uses. However, many participants in the futures markets are simply hoping to profit from changes in price of such commodities. If a futures contract is purchased and the commodity's market price significantly increases, the holder of that contract may then sell it at a profit. This practice is called speculation.

Forward contracts are similar in many respects to futures contracts. Like futures, there are frequently used to sell commodities that are not immediately available for use. Unlike futures contracts,...