Call On A Put

If there was a 1920s musical about options trading, this might have been the name of Cole Porter song. Instead, we've got "Begin the Beguine."

A call on a put is a relatively simple concept, though it can seem a little complicated if you're a newbie to the options market. To enact the strategy, you buy a call option on a put option.

Remember: in options trading, a call option is the right (but not the obligation) to buy some underlying asset. In this case, the underlying asset is a put option on a separate underlying asset (like a stock, a bond, a commodity or a currency). A put is the right to sell a certain asset and represents a way to bet that the price of the underlying asset will go down.

A call on a put is one of four different compound options (which basically means an option that comes inside another option...like a Russian doll). You think a stock will go down. You don't want to take the risk of shorting the stock directly. However, you're also not ready to use a put option just yet...so you go one step removed: you acquire the right to a put option. This allows you more time to figure out if your guess about the stock is right. (See Call on a Call).

This type of strategy isn't exactly efficient (you have to pay for the call, then if you exercise it, you have to pay for the put). It can also involve a good deal of volatility, because now you're using a derivative of a derivative.