Understanding Call and Put Options

What is an Option?

A call option is an agreement that grants the holder of the option the right to willingly sell or buy an underlying asset at a certain price within a specific duration. This is mainly used in stock markets, but this can be further developed towards other assets such as commodities and currencies, among others. Strike price refers to a predetermined price where an option can get exercised, and an expiration date refers to a specified time frame.

 

What is a Call Option?

A Call Option is the right, but not the obligation, of the buyer to buy an underlying asset (security) at the strike price before or on the expiration day. This is a deliberative action in place to buy the asset. Investors buy a Call Option of an underlying asset when the price is reportedly low.

 

Let’s say you bought a Company XYZ Call Option at ₹500 strike price, expiring in a month. If the stock were to touch ₹550 before the option expiry date, you would exercise your right to buy the same stock at ₹500 in order to sell at ₹550; thereby, you would book your profit.

 

However, if it does not touch ₹500, you are under no obligation to buy that stock, and your only loss would be the premium that you paid for the purchase of the option.

• Bullish Strategy: Call options are often bought when you expect the price of the underlying stocks to appreciate.
• Limited Risk: Loss that will be incurred by you is limited and it is just equal to the premium price paid for buying this option.
• Unlimited Profit Potential: Potential profit will be unlimited theoretically as the price of that particular security can rise to any limit.

 

What is a Put Option?

A Put Option lends the holder the right, not the obligation, to sell underlying assets (securities) at the strike price on or before their expiration date. Investors purchase Put Options if they believe the price of the underlying asset might fall.

 

You own shares of Company ABC, and you believe that the stock price might drop. You place a buy for Put Option with a strike price of ₹200, expiring in two months. When the stock price drops to ₹150, you exercise your option and sell shares at ₹200, thus protecting your investment from further losses. There will be a loss on the premium paid only if it stays above ₹200, and hence, there will be no need to exercise the option.

• Bearish Strategy: One exercise Put options usually if you think the price of the underlying will consequently drop.
• Limited Risk: The maximum a person loses in this strategy will only be the premium price paid for the option.
• Huge Potential Gain: There are massive gains if the prices of the underlying fall dramatically.

 

Some Key Differences Between Call and Put Options

Here are the key and main differences between the call and put options:

 

	Call Option	Put Option
Market Expectation	This is when the investor has a positive market outlook, in this case, expecting the prices of an underlying to go up.	When the investor expects the price of the asset to fall, this signifies a bearish outlook.
Right to Buy or Sell	The right to buy the underlying asset at a given price is called the strike price.	The right to sell the underlying at a given price is called the strike price.
Profit	Absolute profit if the price of the underlying stock goes up.	The profit potential is rather significant, given a fall in the price of the asset.
Risk	The risk is limited to the premium.	There is a potential risk of loss, which is limited to the premium paid.

 

Conclusion

If you are desirous of entering the market of options trading, you must be aware of the differences between Call and Put options. Both the option types achieve a different mission according to market expectations. Whether you are trying to hedge against potential losses or rising further up in price, knowing when and how to use Call and Put options can do a great deal for your trading strategy.