While the equity market is recognised for long-term investing, most traders trade in the futures and options markets to make short-term gains from the market. This market segment comes with the benefit of quick money along with a very high risk. However, options trading has some advantages, like higher returns, numerous strategies for hedging risk, and cost efficiencies, etc.
Even those with a background in finance find the options trading market a difficult arena. Depending on the option’s style, an option is a contract that grants the holder the right—but not the obligation—to buy or sell a defined quantity of the underlying security at a specified strike price on or before a stated date. Before making money from it, one needs to comprehend many technical words like “CE,” “PE,” “lot size,” “Strike price,” and the list goes on.
Understanding CE and PE in the Stock Market
CE and PE are terms used by option traders. CE refers to Call Option, and PE means Put Option. Let’s understand these in depth.
The Call Option in the stock market allows the bearer the right—but not the obligation—to purchase a stock, good, bond, or another asset at a particular price within a pre-specified time window. If the value of the asset rises, the stock buyer gains. However, buying a call option on a security gives the buyer the chance to purchase shares at a predetermined price (the striking price) before a specific date (the expiry date).
In option trading, another kind of contract is PE (Put Option), which gives the option holder the right, but not the obligation, to sell particular securities within a given timeframe for a specific price (the strike price). PE could be exercised by investors or traders who expect the underlying asset’s price to decline.
What are the Differences between the Call Option and the Put Option?
|Call Option||Put Option|
|1||Enables traders or investors to purchase a stock at a strike price within a specified time frame.||Enables traders or investors to sell a stock at a strike price within a set time limit.|
|2||Call option buyers can exit the contract in case of expected losses, as there is no compulsion.||Put option holder is required to carry out the trade if the call option buyer has fulfilled their obligation|
|3||The holder buys the stock.||The holder sells the stock.|
|4||If the value of underlying securities rises, then the holder makes a profit.||If the underlying securities value falls, then the holder makes a profit.|
|5||There is unlimited gain as it is impossible to predict the rise of the share price.||There is limited gain due to selling costs.|
Role of Put Call Ratio (PCR) in Options Trading
The Put-Call Ratio, or PCR, is a calculation that compares the volume of Puts to the number of Calls over a given time period to inch the market mood and anticipate future price movement. When the Put-Call Ratio is high, the market’s overall prognosis is adverse; when it is comparatively low, the outlook is positive.
You can calculate the Put-Call Ratio by using two formulas:
PCR = Put Volume / Call Volume (Volumes would be used on a particular day)
PCR = Total Put Open Interest / Total Call Open Interest (Put Open Interest and Call Open Interest would applied on a specific day)
Points to Consider While Analysing PCR
- A PCR number below 1 generally indicates that more Call options are being bought than Put options, which suggests that investors are predicting a bullish outlook for the markets going forward.
- A PCR number above 1 similarly shows that more Put options are being bought than Call options, which implies that investors are predicting a gloomy picture for the markets going forward.
- A PCR score of 1 or nearly 1 indicates no discernible trend in the markets and that almost equal numbers of Call and Put options have been purchased.
Benefits of Investing in Option
- Options allow you to increase your control over the underlying asset by leveraging a relatively small investment.
- Options trading can help hedge existing investments, ultimately lowering the risk of losses in erratic markets.
- Options trading enables investors to profit from short-term price swings by engaging in strategic speculation.
- Options provide a way to make money via a collection of premiums from the sale of options contracts.
Risks Associated with Call and Put Option
- Options contracts come with a set expiry date, leaving the investor a constrained window to turn a profit. The investor could lose money if the market doesn’t move in the desired direction.
- The option market is exposed to risks from the volatility of the market. The significant price swings in the underlying asset may cause the investor to suffer substantial losses.
- The option trading options require a deep understanding of the market and the underlying asset. Investors could suffer significant losses if they don’t understand the options trading fundamentals.
The cycle of options contracts includes both call and put options. Those who purchase call options have the right to buy shares, whereas those who purchase put options are required to sell shares. Profits are made based on market movements and a predetermined price.
What is Options Trading?
Options trading is a method of hedging market positions. Traders can use options to forecast price changes in the stock market. It gives the choice to buy or sell an underlying asset within a specific time at a defined price, but not the obligation to do so.
How does Options Trading Work?
Trading in options contracts enables investors to benefit from changes in the stock market. Traders can use options to predict price changes in the stock market. Put options give the holder the right to sell the asset, whilst calls provide the right to buy the asset.
What do you mean by the Call Option and Put Option?
A call option allows the holder to buy an underlying asset or contract at a fixed price today and at a later date that is also predetermined. On the flip side, the put option is the right to sell an underlying asset or contract at a specified price at a later time but at a price that is determined today.
Who Regulates Options Trading in India?
The Securities and Exchange Board of India (SEBI) is the governing body for the financial market of India. It was established in 1988, and the Securities and Exchange Board of India Act 1992 is the source of its authority.