What are Call Options ?
Suppose you purchased a call option for 100 shares of company A at ₹120 per share (strike price) for Sep. 1 (Expiry Date). You can exercise the right to buy the shares at ₹120 regardless of the prevailing stock price on Sep. 1. This is a good example of call option meaning in practice.
In the above case, the trader would expect the stock price of company A to rise, thereby allowing them to buy it at a lower cost than its market price. If the market price of share is lower than the strike price locked by the option buyer, they can choose to not exercise the right. They will only lose the premium they paid for the option.
Another example is buying a call option for ₹200 premium (premium of ₹2 per share for 100 shares), which expires in two months. The strike price is ₹40 per share, and the stock is expected to go to ₹50 in two months. If the stock price rises to ₹50 on the expiry date, you can exercise your right and buy the shares at ₹40 per unit. The special thing about trading in options is that you are not obligated to exercise the contract, so if the share prices do not stay in your favourable range, you can choose not to exercise the contract and the loss on the trade will only be the premium amount you have paid, i.e., ₹200.
Call options are contracts that provide the trader with the right, not the obligation, to purchase the security at a pre-defined price on the expiry date. A buyer of a call option speculates that the security prices will rise; therefore, they take a position at a lower strike price and make a profit when the securities’ price rises. The Put Call Ratio (PCR) can help traders gauge market sentiment when analyzing the performance of call options.
What are Put Options?
For example, you own 100 shares valued at Rs.100 per share. You analyse that the stock can decline to Rs.90 over the next two months. You invest in a put option with the right to sell those 100 shares at a strike price of Rs.100 on the expiry date, which is two months later. This illustrates the put option meaning in action. If on the expiry date, the share price falls below Rs.100, you can choose to exercise the option
Put options are contracts that provide the trader with the right, not the obligation, to purchase the security at a pre-defined price on the expiry date. A buyer of call option speculates that the security prices will rise, therefore, they take position at a lower strike price and make profit when the securities’ price rises.
Call Option in Share Market
Suppose you purchased a call option for 100 shares of company A at Rs.120 per share (strike price) for Sep. 1 (Expiry Date). You can exercise the right to buy the shares at Rs. 120 regardless of the prevailing stock price on Sep. 1.
In the above case, the trader would expect the stock price of company A to rise, thereby allowing them to buy it at a lower cost than its market price. If the market price of share is lower than the strike price locked by the option buyer, they can choose to not exercise the right. They will only lose the premium they paid for the option.
Another example is buying a call option for Rs.200 premium (premium of Rs. 2 per share for 100 shares), which expires in two months. The strike price is Rs.40 per share, and the stock is expected to go to Rs.50 in two months. If the stock price rises to Rs.50 on the expiry date, you can exercise your right and buy the shares at Rs.40 per unit. The special thing about trading in options is that you are not obligated to exercise the contract, so if the share prices do not stay in your favourable range, you can choose not to exercise the contract and the loss on the trade will only be the premium amount you have paid, i.e., Rs. 200.
Additional Read : What is Demat Account
Call Option Example in Share Market
Consider an investor in the Indian stock market who believes that the price of Reliance Industries’ shares, currently priced at ₹2200, will increase over the next month. The investor buys a call option with a strike price of ₹2300 and a premium of ₹50. If, by expiry, the price rises to ₹2400, the investor can exercise the option and buy the shares at ₹2300, making a profit of ₹100 per share, minus the premium paid. If the price doesn’t reach ₹2300, the call option expires worthless, and the investor loses only the premium. This illustrates how call options can provide significant profit potential when the market moves in the expected direction, a key feature of call and put options as compared to traditional stock trading.
Selling/ Writing a Call Option
The key consideration for a call option writer/seller is the declining asset price and the option's expiration date. It is used to hedge against a possible drop in underlying stock price. The option seller keeps the premium paid by option buyer as profit. Option seller must pay a higher margin compared to option buyer to take position. The ideal time considered by traders to sell a call option is when the underlying asset price is not expected to rise before the expiration. Call options are sold as:
- Covered Call Option - When the seller possesses the underlying asset.
- Naked Call Option - When the seller sells the option without possessing the underlying asset.
How Does a Call Option Work in Trading?
When trading call options, the buyer gains the right, but not the obligation, to purchase an asset at a specific strike price before the option expires. If the price of the underlying asset rises above the strike price, the buyer can exercise the option to purchase it at the lower strike price, realising a profit.
In contrast, if the price of the underlying asset remains below the strike price, the call option expires worthless, and the buyer loses only the premium paid. This limited loss and the potential for unlimited profit make call options an attractive choice for traders anticipating price increases.
Put Option in Share Market
For example, you own 100 shares valued at Rs.100 per share. You analyse that the stock can decline to Rs.90 over the next two months. You invest in a put option with the right to sell those 100 shares at a strike price of Rs.100 on the expiry date, which is two months later. If on the expiry date, the share price falls below Rs.100, you can choose to exercise the option.
Put Option Example in Share Market
For instance, suppose an investor buys a put option on a stock like Tata Motors with a strike price of ₹1000. If the stock price drops to ₹900 before the expiration date, the investor can sell the stock at ₹1000, gaining ₹100 per share. However, if the stock price stays above ₹1000, the investor will not exercise the option and will lose only the premium paid for the put option.
How Does a Put Option Work in Trading?
In put option trading, the buyer secures the right to sell the underlying asset at a fixed strike price. This is beneficial when the market price of the asset is expected to decrease. If the price falls below the strike price, the buyer can sell the asset at the higher price, making a profit.
The seller, on the other hand, has the obligation to buy the asset at the strike price if the option is exercised. Put options are often used as a hedge against falling prices or for speculative trading in declining markets.
Put Option Buying
Buying puts appeals to traders expecting a decline in the underlying asset price. It protects you from losses against a small amount of premium.
You need to choose the strike price first, i.e., the price at which you will sell the asset on the future date. Choose an expiration date.
You can monitor the stock prices to gauge if the option contract is helping you hedge the risks. You can let the option unused if the stock price does not stay in your favourable range. There will be no profit, but your losses will not be more than the option premium.
Additional Read : Documents Required for Opening a Demat Account
Put Option selling
Put Option sellers expect a rise in the value of the underlying asset. They have to pay the margin to take position. Also, option seller must settle the daily Mark-to-Market (MTM) basis the change in option prices.
Call vs Put Option
Parameter
| Call Option
| Put Option
|
Meaning
| Provides the right to buy an asset
| Provides the right to sell an asset
|
Investor’s Expectation
| Expects the price of the asset to increase
| Expects the price of the asset to decrease
|
Maximum Profit
| Unlimited
| Limited (price cannot fall below zero)
|
Maximum Loss
| Limited to premium paid
| Limited to premium paid
|
Ideal Action
| Exercise if in the money, let expire if not
| Exercise if in the money, let expire if not
|
How to Calculate Call and Put Option Payoff?
To calculate the payoff of both call options and put options, the spot price of the underlying asset at expiry is compared to the strike price. The payoff for call options is calculated as the difference between the spot price and the strike price, minus the premium paid.
For put options, the payoff is the difference between the strike price and the spot price, minus the premium. In both cases, if the option expires out of the money, the loss is limited to the premium paid.
Call Option Payoffs
The payoff from call options depends on the relationship between the strike price and the market price of the underlying asset at expiry. If the price of the stock exceeds the strike price, the call option holder makes a profit. For example, if an investor buys a call option for Reliance Industries at a strike price of ₹2300, and the stock price rises to ₹2400, the investor gains ₹100 per share, minus the premium paid. This shows how call options offer unlimited profit potential as the market price increases.
However, if the market price does not rise above the strike price, the call option expires worthless. For example, if the stock price remains at ₹2200, the call option holder loses the premium paid, which is the maximum loss. This is a key characteristic of call and put options, where the buyer’s loss is limited to the premium.
The risk-reward structure of call options makes them attractive for investors expecting a significant price movement. Unlike put options, where the potential loss is more defined, call options offer substantial upside if the price moves in the right direction, as seen in call vs put option strategies.
Put Option Payoffs
The payoff from put options depends on how the market price of the underlying asset compares to the strike price at expiry. When the market price falls below the strike price, the put option holder profits. For example, if an investor buys a put option for Tata Motors at a strike price of ₹450, and the stock price drops to ₹400, the investor gains ₹50 per share, minus the premium paid. This illustrates how put options are beneficial when expecting a price decrease.
Conversely, if the stock price remains above the strike price, the put option expires worthless. For instance, if the stock price of Tata Motors stays at ₹470, the put option holder loses the premium paid, which is the maximum loss. This highlights the put option meaning in that the buyer’s risk is limited to the premium, offering a defined downside.
In the context of call vs put option, put options are typically used for hedging purposes, offering protection in bearish market conditions. Put Option Example further demonstrates their role in portfolio risk management, contrasting with the unlimited potential gains from call options.
Summarising Call & Put Options
Thus, the call and put options are the opposite of each other. Where buying a call allows you to buy an underlying security at a fixed price on expiration, when price of underlying is expected to rise. A put option is bought when the asset price is expected to go down and it gives the right to sell the underlying stock at predefined price on expiration.
Concluding Lines
A put option is bought when the asset price is expected to decline, giving the right to sell the underlying stock at a predefined price upon expiration. For more detailed information and to explore trading options, download Bajaj Broking App.
