What are Call and Put Options? Meaning, Types, Examples, and Differences
- Dipali Waghmode
- Sep 8
- 11 min read
Call and put options are common contracts or derivatives that give the buyer rights. There is no requirement, nevertheless, to buy or sell the underlying asset by a given date or at a given price. Options are segregated into two categories, namely put and call options. While a put option permits the holder to sell the asset at a given price within the same term, a call option grants the holder the right to buy the asset at a fixed price prior to the contract's expiration. These options are frequently employed in trading methods to speculate on price fluctuations or to hedge against hazards.
Table of Contents
What are Options?
An option is a derivative contract that grants the right, but not the responsibility, to purchase or sell the underlying within a given time frame and at a predetermined price. The option seller receives the premium together with the duty to sell or purchase the underlying asset in the event that the buyer exercises his right, while the buyer pays the premium and purchases the right. These options come in two varieties, such as call and put options, each of which has unique rights.
The right to purchase the underlying asset is granted via call options.
The ability to sell the underlying asset is granted via put options.
These options give investors flexibility and leverage and are mostly utilised for speculating, arbitrage, and hedging.
What is a Call Option?
A common contract that gives a buyer the right to buy is a call option. As a result, purchasers are able to acquire a certain security, such as stocks, at a specific price. Above all, call options should have expiration dates. Unusual and sophisticated options on a variety of financial securities are handled by many institutions, it is true. Nonetheless, a wide range of securities, including currencies, swaps, ETFs, and more, can be used to buy and sell call options. Investors who buy a call option do not actually need to buy and sell the underlying asset at the strike price.
How Does a Call Option Work?
When a buyer exercises a call option, the seller gets a premium and is obligated to sell the asset at the strike price. The buyer pays the premium for the right to buy the asset at the strike price.
Profits and Losses: If the asset's price rises beyond the strike price plus the premium paid, the buyer makes money; if the asset's price stays below the strike price and the option expires worthless, the seller makes money.
Example: Assume that XYZ stock is valued at Rs. 100 per share. Investor B owns these 100 shares and hopes to earn more than just dividends. Furthermore, it is unlikely that stocks would rise above Rs. 150 in the upcoming month. B evaluates call options and discovers a Rs. 150 call trading where each contract is worth 50p. Thus, the investor earns Rs. 50 as the premium amount after selling one call option. The buyer’s option will grow to the right if the price of the shares surpasses Rs. 150. Additionally, B must provide the shares at a price of Rs. 150 each. B, however, is allowed to keep the shares without influencing any sales if the price stays below Rs. 150.
What is a Put Option?
A buyer who purchases a put option has the option to sell the underlying asset at the strike price. The buyer is not required to follow suit, though. However, when the put buyer begins exercising their option, the "put option" seller must purchase the asset. Most investors only buy "puts" only when they are certain that the price of the underlying asset will dip. Similarly, once they are certain that the underlying assets will rise, they sell puts.
How Does a Put Option Work?
When a put option is exercised, the buyer pays a premium for the right to sell the asset at the strike price, and the seller is paid a premium and is obligated to purchase the asset at the strike price.
Profits and Losses: If the asset's price drops below the strike price less the premium paid, the buyer makes money; if the asset's price stays above the strike price and the option expires worthless, the seller makes money.
Example: For example, A buys one put option on PQR Ltd for Rs. 100. Additionally, he has the right to sell 100 PQR shares at Rs. 100, even if each option contract is worth 100 shares. This privilege is still in effect prior to its expiration date, though. If A already owns 100 PQR shares, his broker will sell them for the strike price of Rs. 100. An option writer will buy the shares at the same price to finalise the deal.
Differences Between Call and Put Option
Feature | Call Option | Put Option |
Meaning | A financial contract offering the right to buy an asset at a specific price before the date of expiration. | A financial contract offering the right to sell an asset at a specific price before the date of expiration. |
Buyer’s Expectation | Bullish | Bearish |
Seller’s Expectation | Bearish | Bullish |
Profit Potential | Unlimited | Unlimited |
Buyer’s Risk | Limited to the premium paid | Limited to the premium paid |
Seller’s Risk | Unlimited | Unlimited |
Exercise | The option can be exercised to buy the underlying asset at the strike price | The option can be exercised to sell the underlying asset at the strike price |
Premium | Paid by the buyer to the seller for the buying right | Paid by the buyer to the seller for the selling right |
Price Movement Impact | Profitable if the asset price exceeds the strike price | Profitable if the asset price dips below the strike price |
Investors Usage | To speculate on the price increase or hedge against rising prices | To speculate on the price decrease or hedge against falling prices |
Strike Prices Types for Call and Put Options
A key idea in options trading is the strike price, sometimes referred to as the exercise price. This is the set price in the option contract specifies. It stands for the fixed price at which option contracts are exchanged. At the beginning of the options contracts, the exchange sets this fixed price, which doesn't alter until the contract's expiration. An important determinant of an option's moneyness is the relationship between the strike price and the spot price, which can be divided into three categories.
In-the-Money (ITM)
A contract is said to be "In-the-Money" when the strike price is close to the current market price.
Call Option: The strike price for the call option is below the underlying asset's current market price and is regarded as ITM.
Put Option: The put option is regarded as ITM if the strike price exceeds the underlying asset's current market price.
At-the-Money (ATM)
The contract is referred to as "At-the-Money" when the strike price and the current market price are close.
Call Option: The strike price for the call option is close to the underlying asset's current market price and is regarded as ITM.
Put Option: The put option's strike price, which is regarded as ITM, is close to the underlying asset's current market price.
Out-of-the-Money
A contract is regarded " Out-of-the-Money" when the strike price and the current market price are close.
Call Option: The strike price for the call option is higher than the underlying asset's current market price and is regarded as ITM.
Put Option: The put option is regarded as ITM if the strike price is less than the underlying asset's current market price.
How to Buy Call Option?
Choosing an asset, an expiration date, and a strike price are the steps to initiate the process of purchasing a call option. Depending on the strike price, the period until expiration, and the current price of the stock, you will pay a premium for the option. Your option gains value if the stock price climbs over the strike price, at which point you may either wait for it to expire or sell it for a profit.
How to Sell Call Option?
You are obligated to sell the underlying asset when you sell a call option. The underlying assets, such as stocks and indexes, are often owned by sellers. Selling the option gives you the premium and you want to keep it as profit, particularly if the stock price is below the strike price. If the price of the underlying asset surges, the call options' risk of selling at the strike price could be indicative of lost profits.
How to Buy Put Option?
Purchasing a put option entails acquiring the right to sell an underlying asset before the option's expiration date at a predefined strike price. Choosing an asset, an expiration date, and a strike price are the first steps in purchasing a put option. Depending on the strike price, the period until expiration, and the current price of the stock, you will pay a premium for the option. Your option gains value if the stock price drops below the strike price, at which point you may either wait for it to expire or sell it for a profit.
How to Sell Put Option?
By selling a put option, you commit to purchasing the underlying asset in the event that the buyer exercises the option. If you think the asset's price will remain above the strike price, you'll probably employ this kind of technique. Put sellers get paid in advance and hope the option expires worthless so they can keep the premium as profit. Selling puts, however, carries the risk that, should the asset drop below the strike price, you will have to purchase it at that price.
How to Calculate Option Payoffs?
Both call and put options' payoffs are determined by comparing the strike price and the spot price of the underlying asset at expiration.
Call Option Payoff
The holder of a call option can purchase the underlying asset at the predetermined strike price. The difference between the price of the underlying asset and the strike price at expiration determines the possible payout of a call option.
Call Payoff = max (0, Spot Price−Strike Price)
Spot Price: The market price of the underlying asset.
Strike Price: The price at which the underlying asset can be bought.
Example:
Strike Price: Rs. 1,800
Spot Price at Expiration: Rs. 2,000
Call Payoff = max (0,2000−1800) = Rs. 200
By exercising the option to purchase the stock at Rs. 1,800 and sell it at the market price of Rs. 2,000, the call option holder earns Rs. 200 as profit. The option holder would not have exercised the option since it would have been less expensive to purchase the asset on the open market if the spot price had dropped to Rs.1400. As a result, there would have been no payout.
A call option has an infinite potential reward. The value of the call option rises sensibly in tandem with the price of the underlying asset.
Put Option Payoff
The holder of a put option can sell the underlying asset at the predetermined strike price. As the price of the underlying asset falls, a put option's payout increases.
Put Payoff = max (0, Strike Price−Spot Price)
Spot Price: The market price of the underlying asset at expiration.
Strike Price: The price at which the underlying asset can be sold.
Example:
Strike Price: Rs. 2,000
Spot Price at Expiration: Rs. 1,800
Put Payoff = max (0,2000 – 1800)= Rs. 200
The put option holder can profit by Rs. 200 by exercising the option to sell the asset at Rs. 2000 and repurchase it at the market price of Rs. 1800. Since it would have been more advantageous to sell the asset on the open market rather than execute the option, the payment would have been zero if the spot price had been Rs. 1600.
If the asset price drops to zero, the maximum payout is capped at the strike price. This is due to the fact that a stock or asset's lowest value could have been zero.
Factors Affecting Call and Put Payoffs
The link between the asset's strike price and spot price at expiration is crucial to comprehending option payoffs.
Premiums and the cost of purchasing the option are important factors, even though the strike price determines the payout. The option premium must be taken into account when calculating total profit or loss.
An option's likelihood of turning a profit increases with the amount of time left before it expires. Time decay is the term used to describe how options lose value over time.
Excessive volatility raises the possibility of significant price swings, which may have an impact on the payout.
Conclusion
The functions of call and put options are opposite. When a price increase is expected, a call option grants the right to purchase an asset at a predetermined price when it expires. On the other hand, a put option is bought when a drop is anticipated. Investors can improve portfolio management by making well-informed judgements by being aware of the main distinctions between these options. Options trading does, however, carry a unique set of dangers, such as the possibility of losing just the premium paid by purchasers and the seller's duty to execute the conditions of the contract in the event that it is exercised. In the end, options are strong instruments in a trader's toolbox that require study and strategy to optimise their gains.
FAQs
1. What is the difference between CE and PE?
A put option gives the holder the right to sell the underlying asset at a specific strike price within a specified timeframe, whereas a call option is a contract with a fixed expiration date that allows the holder the right to buy the underlying asset at a specified strike price within a set term.
2. What is Moneyness?
Moneyness is the ability to comprehend how the strike price and the spot price relate to one another (ITM, ATM, OTM).
3. What are the types of trading?
Day trading, swing trading, scalping, and position trading are common varieties.
4. Can I sell an option before its expiry?
Yes, you can reduce losses or book profits by selling the option before it expires. We refer to this as shutting your position.
5. What happens to a call or put option at expiration?
If the strike price of a call option is less than the market price of the underlying asset at expiration, the option is exercised, resulting in a profit. The option expires worthless if the stock price doesn't increase over the strike price. If the strike price of a put option exceeds the market price, the trader will profit and the option will be executed. The put option expires worthless if the market price rises over the strike price.
6. When should you buy a call option
When you anticipate an increase in the price of the underlying asset, it is a good time to buy a call option. The meaning of the call option is that it grants you the right to buy the asset at a predetermined price. Purchasing a call option allows you to profit from prospective price increases without having to make the full purchase of the item.
7. Can you sell a call or put option without owning the underlying asset?
Although it is seen as a high-risk tactic, it is possible to sell a call or put option without actually owning the underlying asset. We call this selling naked options. Whereas naked puts can result in large losses if the price drops, naked call options carry limitless risk if the stock price increases sharply.
8. What is a butterfly strategy?
To take advantage of low volatility, a neutral options strategy entails purchasing and selling options at various strike prices.
9. What are Nifty and Sensex?
A basket of leading equities is represented by the benchmark indexes of the NSE (Nifty) and the BSE (Sensex).
10. How do call and put options affect portfolio hedging?
In portfolio hedging methods, call and put options are frequently employed. While call options can hedge a short position, put options can shield a long position from downside risk. Put and call options give investors flexibility in volatile markets by limiting possible losses while preserving the chance for gains.
11. Is it safer to buy calls or puts?
The call and put options are not significantly superior to one another. But it really relies on the investor's risk tolerance and investment goal. However, the majority of the risk ultimately rests on changes in the market price of the underlying asset.
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