What is it called when you buy a put and sell a call option?

When you buy a put option and sell a call option with the same expiry date and same strike price simultaneously for the same underlying asset at a certain point in time, then this trading strategy is called a Straddle.

What are the 4 types of options?

The four types of options positions are buying a call option, selling a call option, buying a put option, and selling a put option.

Which is better call or put option?

Buying a put option is better if you expect the markets to experience more volatility or expect the market to turn bearish. In contrast, buying a call option is better when you expect the markets to turn bullish.

Can I buy and sell options same day?

Yes, you can buy and sell options on the very same day.

Which option strategy is most profitable?

Generally, the most profitable options strategy is to sell ‘out-of-the-money’ put and call options. Through this strategy, you can collect large amounts of option premiums while also capping your risk. However, your strategy would differ if you are looking to hedge your position.

What rights does a call option give me, and how does its payoff work?

A call option grants the buyer the right, but not an obligation, to purchase an asset at a defined strike price before expiry. The payment is equal to the market price minus the strike price, reduced by the premium paid.

What is the break-even point for a call or put option position?

For a call option, the break-even point is equal to the strike price plus the premium. For a put option, it is the strike price minus the premium.

Why might an investor prefer options over buying the underlying asset itself?

Investors choose options because they involve minimal capital and have higher potential returns. They also contribute to better risk management and market volatility hedging.

Call & Put Options: How to Buy and Sell?

Call options are the type of option that increases in value as the price of the underlying stock increases. They are the most well-known type of option, allowing the owner to lock in a price to purchase a specific stock by a specified date. Call options are attractive because they can appreciate rapidly in response to a slight increase in the underlying stock price. As a result, they are traders' favourites seeking a significant profit.

Key Takeaways

Call and put options enable traders to profit from price changes without owning the asset.

When prices rise, a call option gains value, whereas a put option profits when prices fall.

Buyers' losses are restricted to the premium, but sellers may face more risk.

Understanding terminologies like strike price, premium, expiration, and settlement is critical for successful trading.

What is a Call Option?

A call option provides the right, not the commitment, to acquire a stock at a set price (strike price) by a predefined date at the expiration of the option. The call buyer will pay a premium for this right, which the call seller will receive. Unlike stocks, which can exist in perpetuity, an option will expire either worthless or have some value.
The following components are an option's primary characteristics:

Strike price: The price where the underlying shares can be purchased.

Premium: The cost of the option, payable by either the buyer or the seller.

How Does Call Option Work?

A call option allows an investor to profit from a prospective increase in the price of a stock without purchasing it outright. It works via an agreement in which the buyer pays a tiny premium to gain the right, but not the obligation, to purchase the underlying asset at a fixed price, known as the strike price, before the option expires.

If the asset's market price increases over the strike price, the call option becomes advantageous since the buyer may now acquire the asset at a lower, fixed cost. The buyer's profit equals the difference between the market and strike prices, less the premium paid.

If the price remains below the strike price, the call option expires in vain, with the trader losing only the premium amount. As a result, this option has a low downside risk but a limitless profit potential as prices rise.

Example Of a Call Option

Assume a trader who predicts the price of ABC Ltd.'s shares will climb in the following month. The trader purchased a call option contract having a strike price of ₹1,050 at a premium of ₹30 per share, with the shares now trading at ₹1,000. Each contract represents 100 shares, hence the total price paid is ₹3,000 (₹30 x 100).

If the share price reaches ₹1,100 before expiration, the option becomes lucrative. The intrinsic value is ₹50 per share (₹1,100-₹1,050). After subtracting the premium of ₹30, the trader's profit per share is ₹20, totalling ₹2,000 (₹20 x 100). However, if the stock price continues below ₹1,050 at expiry, the call option becomes worthless and the trader loses the premium paid.

This example demonstrates how call options provide leveraged exposure. The trader risks just the premium but has the potential to benefit significantly if the stock moves in a favourable direction.

What is a Put Option?

A put option is a kind of derivative contract in which the buyer has the right, but not an obligation, to trade an underlying asset at a given price, called the strike price, within a specified time period. It serves as a strategy for investors who believe the asset's price will fall in the future.

When the stock's market price falls beneath the strike price, the put option becomes more valuable since the buyer is able to sell the shares at the higher strike price. If the buyer exercises the option, the seller is compelled to acquire the asset for the specified price.

If the stock price remains above the strike price, the put option becomes worthless, and the buyer loses just the premium paid for it. This characteristic makes it a great tool for hedging against prospective losses or speculate on downside market fluctuations, as the maximum loss is restricted to the premium amount.

How Do Put Options Work?

A put option works based on how a stock's market price fluctuates compared to its strike price. When an investor purchases a put option, they pay a tiny premium to guarantee the right to sell the stock at a specified price before the expiry date.

If the market price falls below the strike price, the buyer can choose to exercise the option and sell the stock at the higher, agreed-upon price. The profit is equal to the gap between the strike price and the market price, minus the premium paid. If the market price remains above the strike price, the option will simply expire, with the buyer losing merely the premium.

Sellers, on the other hand, receive the premium upfront but risk having to purchase the stock at a higher strike price if the purchaser executes the contract. This approach allows traders to hedge downside risk or speculate on declining markets while limiting capital exposure.

Example Of a Put Option

To illustrate how a put option works, assume an investor who predicts the shares of ABC Ltd. to decrease from ₹1,000 to ₹900 in the short term. The investor purchases a put contract with a strike price of ₹1,000, paying a premium of ₹25 per share. Each contract covers 100 shares, hence the total price paid is ₹2,500 (₹25 x 100).

If the share price drops to ₹900 before expiry, the investor may sell the shares for ₹1,000 and earn ₹100 per share. After subtracting the ₹25 premium, the net gain is ₹75 per share, totalling ₹7,500 (₹75 x 100).

However, if the share price remains over ₹1,000, the put option becomes worthless, and the trader just loses the ₹2,500 premium. This example demonstrates how options may assist investors in hedging against falling prices or profit from unfavourable trends while minimising their potential losses.

Difference Between a Call Option And a Put Option

Here are the major differences between a call option and put option, helping traders understand how each functions in opposite market scenarios:

Basis of Difference	Call Option	Put Option
Purpose	Used when investors predict a stock's price to grow.	Used when investors predict the price of a stock to fall.
Right Granted	Gives the buyer the option to purchase the underlying asset at a fixed price.	Gives the buyer the right to sell the underlying asset at a fixed price.
Profit Scenario	Profitable when the market price exceeds the strike price.	Profitable when the market price falls below the strike price.
Risk to Buyer	Limited to the premium paid.	Limited to the premium paid.
Obligation of Seller	Seller must sell the asset if the option is exercised.	Seller must buy the asset if the option is exercised.
Market View	Bullish	Bearish

Options on Call vs Options on Put

The other primary option type is the put option, which increases in value as the stock price falls. Thus, traders can bet on the reduction of stock by purchasing put options. In this way, puts are the stark opposite of call options, although they carry a lot of the same risks & rewards:

As with buying a call option, buying a put option enables you to earn many times the initial investment.
As is the case with purchasing a call option, the risk involved is that you may lose your entire investment if put expires worthless.

As with writing call options, selling put options generates a premium, but the seller assumes the complete risk if the underlying stock moves in a negative direction.

Compared to selling a call option, selling a put option exposes you to limited losses (since a stock cannot fall below zero). Nonetheless, you risk losing many times the amount of the premium obtained.
Additional information is available on everything you need to know about put options.

Basic Terms Relating to Put and Call Options

Understanding a few fundamental terms helps investors understand how put and call options work in trading:

Underlying Asset: The financial instrument (stock, index, or commodity) that serves as the foundation for the option transaction. Its price changes affect the option's value.

Strike Price: Fixed price at which the buyer can purchase (call) or sell (put) the underlying asset before it expires.

Spot Price: The current market value of the underlying asset. It determines if an option is profitable or unprofitable.

Premium: The amount paid by the option buyer to the seller in exchange for gaining contract rights. It indicates the buyer's greatest potential loss.

Expiry Date: The latest date on which the option may be exercised. After this date, the contract becomes void.

Settlement: The process of closing open option positions upon expiration, either by delivering the underlying asset or paying the cash difference between the strike and market prices.

In the Money (ITM): A call option is ITM when the market price is higher than the strike price, whereas a put option is ITM when the market price is lower.

Out of the Money (OTM): A call or put has no intrinsic value since exercising it would be unprofitable.

Intrinsic value: Difference between the market price and the strike price of an option, reflecting its immediate exercise value.

Also Read, What is an ITM Call Option? Get to Know Here!

How to Calculate Call Options and Put Option Payoffs?

Understanding how to compute option payoffs allows traders to predict prospective earnings and losses while trading call and put options, as they have different payoff structures based on market action.

Formulas

Call Option Payoff (Buyer) = Maximum (0, Spot Price - Strike Price) - Premium

Put Option Payoff (Buyer) = Maximum (0, Strike Price - Spot Price) - Premium.

Option Type	Buyer’s Maximum Loss	Buyer’s Maximum Gain	Seller’s Maximum Loss	Seller’s Maximum Gain
Call option	Premium paid	Unlimited (as the underlying price can rise indefinitely)	Unlimited risk (if the underlying price rises sharply)	Premium received
Put option	Premium paid	Strike price minus premium (since underlying can’t fall below zero)	Strike price minus premium (if underlying falls to zero)	Premium received

Risk vs Reward – Call Option and Put Option

Aspect	Call Option	Put Option
Market outlook	Buyer expects the price to rise	Buyer expects the price to fall
Maximum gain	Unlimited, as the price can keep rising	Limited to the strike price minus the premium
Maximum loss	Limited to the premium paid	Limited to the premium paid
Seller’s gain	Premium received	Premium received
Seller’s loss	Unlimited if the price rises sharply	Limited to the strike price minus premium

When an Option Matures and is Settled?

A contract is an option, and each contract represents shares of the stock. Exchanges quote option prices in terms of the price per share, not the overall cost of ownership. For instance, if an option is quoted on the exchange at ₹7.50 and has a lot size of 100. Then, it will amount to ₹750 (100 shares * 1 contract * ₹7.50) to purchase one contract.

The Operation of a Call Option

When a stock price is greater than the strike price at expiration, the call option is "in the money." The call option owner may exercise it by putting up cash to purchase the stock at the strike price. Alternatively, the owner might sell the option to another buyer at its fair market value before it expires.

The call owner benefits when the premium paid is less than the difference between the stock price and the strike price. For instance, suppose a trader purchased a call for ₹5 with a strike price of ₹200, and the stock is trading at ₹230 at expiration. The option is worth ₹30 (the ₹230 stock price less the ₹200 strike price), and the trader has profited by ₹25 (₹30 less the ₹5 premium).

If the stock price is less than the strike price at the expiration time, the call is "out of the money" and becomes worthless. The call seller retains any premium received for the option.

Why Would You Purchase a Call Option?

The primary benefit of purchasing a call option is that it magnifies the gains in the price of a stock. You can profit on a stock's gains above the strike price until the option expires for a minimal upfront investment. Therefore, if you purchase a call, you typically anticipate the stock to climb before expiration.

Assume that the stock XYZ Ltd. is trading at ₹200 per share. For ₹20, you can purchase a call option on the stock with a ₹200 strike price that expires in eight months. Each contract costs ₹2,000, or ₹20 * 100 shares * 1 contract.

The trader's profit at expiration is shown below:

As you can see, for every rupee gain in the stock price above the strike price, the option's value (upon expiration) increases by ₹100. As the stock goes from ₹230 to ₹240 — a gain of only 4.3 per cent — the trader's profit doubles from ₹1,000 to ₹2,000.

While the option may have been in profit at expiration, the trader may have lost money. Because the premium is ₹20 per contract in this example, the option becomes profitable at ₹220 per share, the ₹200 strike price plus the ₹20 premium. The call buyer earns money only over that level.

If the stock closes between ₹200 and ₹220, the call option retains some value, but the trader loses money overall. Furthermore, if the share price falls below ₹200, the option expires worthless, and the call buyer forfeits the entire investment.

The appeal of buying calls is that they significantly increase a trader's profits compared to directly owning the stock. A trader can purchase ten shares of stock or one call for the exact initial cost of ₹2,000.

If the stock reaches ₹240, then:

The stock investor earns a profit of ₹400, or ten shares multiplied by the gain of ₹40.

The options trader earns ₹2,000, or the ₹4,000 option value (100 shares * 1 contract * ₹40 gain) less the ₹2,000 premium paid for the call.

In percentage terms, the stock returns 20%, whereas the option returns 100%.

Why would you sell a call option?

Each call purchased results in a call sold. Therefore, what are the benefits of selling a call? In summary, the payoff structure for buying a call is the inverse of the payout structure for selling a call. Call sellers anticipate that the stock will remain flat or decrease, and they want to bag the premium with no fallout.

Let us return to the previous example. Assume that the stock XYZ Ltd. is trading at ₹200 per share. For ₹20, you can sell a call option on the stock with a ₹200 strike price that expires in eight months. One contract is worth ₹2,000 (₹20 * 1 contract * 100 shares).

The payout schedule is the polar opposite of the call buyer's:

Each time the price falls below the strike price of ₹200, the option expires with no value, and the call seller retains a ₹2,000 cash premium.

Between ₹200 and ₹220, the call seller retains some, but not all, of the premium.

Beyond the ₹2,000 premium obtained, the call seller loses money above ₹220 per share.

The appeal of selling calls is that you earn a cash premium beforehand and are not required to make any immediate payments. Then you wait till the maturity of the stock. If the stock falls, remains flat, or slightly climbs, you will earn profit. However, unlike a call buyer, you won't be able to quadruple the money. As a call seller, the maximum amount of profit you can earn is on the premium.

While selling a call appears to be a low-risk strategy – and it frequently is — it could become one of the riskiest options strategies due to the possibility of limitless losses if the stock climbs.

For instance, if the stock doubled in value to ₹400 per share, the call seller would lose a net ₹18,000, or the option's ₹20,000 value less the ₹2,000 premium received. However, several safe call-selling tactics, such as the covered call, can be used to aid in the seller's protection.

What Happens to Call Options on Expiry?

Buying a Call Option

When you’re buying a call option, the following events may occur at expiration:

Out-of-the-money (OTM): If the spot price continues lower than the strike price, executing the option makes no sense. The contract expires worthless, with the buyer's loss limited to the premium paid.

In-the-money (ITM): If the spot price exceeds the strike price, the buyer may execute the option. The profit is the difference between the spot and strike prices, less the premium paid.

At-the-money (ATM): If the spot price equals the strike price, the buyer does not benefit from exercise and instead suffers a loss equal to the premium paid.

The buyer's maximum loss is restricted to the premium, while the potential profit is theoretically limitless.

Selling a call option

When you’re selling a call option, the following events may occur at expiration:

Out-of-the-money (OTM): If the spot price stays below the strike price, the option expires worthless and the seller retains the premium as profit.

In-the-money (ITM): If the spot price surpasses the strike price, the seller has to sell the asset at the lower strike price, incurring a loss equal to the gap between the spot and strike prices, less the premium paid.

At-the-money (ATM): When the prices are identical, the seller maintains the premium for profit.

Thus, while the profit is restricted to the premium, the loss is limitless if the asset price rises dramatically.

Also Read, What is OTM Call Options? Understand Here!

What Happens to Put Options on Expiry?

Buying a Put Option

When buying a put option, the buyer obtains the right to sell the underlying asset at the strike price before or at expiry.

In-the-money (ITM): If the spot price goes below the strike price, the buyer can exercise the option and sell the asset for a higher strike price. The profit is equal to the difference between the strike and spot prices, less the premium paid.

Out-of-the-money (OTM): If the spot price continues higher than the strike price, the put expires worthless, with the buyer losing merely the premium.

At-the-money (ATM): When the spot price matches the strike price, exercising provides no advantage and results in a loss equal to the premium.

In this case, the biggest loss is restricted to the premium, while the maximum profit happens when the asset's value falls considerably.

Selling a Put Option

When selling a put option, the seller agrees to purchase the underlying asset at the strike price if the buyer exercises the contract. The seller receives a premium for taking on this risk.

Out-of-the-money (OTM): If the spot price remains above the strike price, the option becomes worthless, and the seller retains the premium as profit.

In-the-money (ITM): If the spot price goes below the strike price, the seller must purchase the asset at the higher strike price, incurring a loss equal to the difference between the strike and spot prices, less the premium.

At-the-money (ATM): When the prices are identical, the seller keeps the premium with no additional profit.

Thus, while the seller's profit is restricted to the premium, the loss might be significant if the asset's value falls dramatically.

Conclusion

While options are hazardous, traders can utilise them prudently. Indeed, when used properly, options can help mitigate risk while still allowing you to profit from a stock's gain or loss. Of course, if you still wish to go for the home run, choices provide that option as well.