A call option is a financial contract that gives the option buyer the right, but not the obligation, to buy an underlying asset (stocks, bonds, commodities, currencies, ETFs, etc.) at a predetermined price or strike price on a predetermined date (expiry date). The seller of the contract is obligated to sell the underlying asset if the buyer decides to buy it.

A put option gives the option holder the right, but not obligations, to sell an underlying asset at a predetermined price on a given expiry date. The option seller is obligated to buy the asset if the option holder decides to exercise the rights.

What are the differences between call option and put options?

These are the key differences between call option and put option. Call option Put option It gives the buyer of the option the right, but not the obligation, to buy an underlying asset. The put option gives the contract holder the right, not the obligation, to sell the underlying asset. Seller of call is obligated to sell Seller of put is obligated to buy The value of the call increases when the underlying asset’s price increases The value of the put option decreases when the underlying asset’s price increases It’s an investment strategy where the asset price is expected to rise. The put option holder expects the asset price to fall. Potential for gain for gain unlimited. Potential for gain is limited to the premium earned from selling.

What is riskier: call or put?

Depending on your strategy, the loss can be limited to the premium amount or result in an unlimited loss.

Does the Out-of-The-Money option have an intrinsic value?

No, the intrinsic value of option will only exist if the option is "in the money." Out-of-the-money (OTM) options do not possess any intrinsic value as it would not be profitable to exercise such options.

Can I sell an option before its expiry?

Yes, you can sell an option before expiry as part of the option selling strategies to realise profits or to minimise losses. Many traders sell Options before expiry to either record profits or to avoid time decay.

What factors influence option prices?

The factors that affect the price of an option are the price of the underlying asset, its volatility, the strike price, time to expiration and prevailing interest rates. Market sentiment and supply and demand are also key factors.

Can I do options trading on Angelone?

Yes, options trading is easy to do on the Angel One trading platform. You can buy or sell the options for a variety of indices and stocks straight through the app or website. Angel One has a set of more advanced tools, live market data, and expert insights to help you make informed trading-based decisions and efficiently carry your option positions.

What is Call Option and Put Option? – A Beginner’s Guide

Call option and put option are the 2 kinds of options available in the stock market. A call option is used when we expect the stock prices to increase while a put option is used when the stock prices are expected to depreciate.

If used with proper planning and risk management, these tools can help you navigate the volatility of the markets in a smoother way. Let’s dive right into these and learn more!

Key Takeaways

Options are contracts that provide the right, but not the obligation, to buy or sell an asset.

Call options are profitable in rising prices, and put options in falling prices.

Strike price, premium and expiry date are the defining factors of the value and risk of an option.

It is important for traders to know option payoffs in order to plan better and manage risks.

Options

An options contract is a contract that gives the buyer the right to either buy (a call) or sell (a put) an underlying asset. However, that is not an obligation. An options contract gets its value from the value of the underlying asset. It has no value of its own. The underlying asset can be a stock, currency or commodity.

The buyer has the option of keeping or canceling the option, that is buying the asset within the stipulated time period mentioned on the contract or letting the asset go.

For example, an option is like a coupon for a gallon of milk. The coupon itself has no value, but it derives its value from the price of milk.

Options Available

Call option

Put option

Call option

This contract gets the buyer the right but not the obligation of buying the asset at a particular price before the expiration date of the contract.

Put Option

This option gives the buyer a right, not an obligation to sell the asset at a particular price before the expiration date of the contract.

What is a Call Option?

Call options are a type of derivative that grants the contract holder the right, but no obligation to buy a specified quantity of an underlying asset at a pre-determined price and date. It gives investors the potential to profit from asset price appreciation without committing to buying. In the market, call options are often used for speculation and hedging.

How do Call Options Work?

Call options are financial contracts that are traded on the stock exchange. A call option can be bought and sold on a variety of securities, like currencies, swaps, ETFs, etc. The call option gives the option holder the right to acquire the underlying security at a predetermined price. However, options are non-binding, meaning there is no obligation associated with them. An equity call option typically has a different number of lots per contract depending on the underlying stock. The option holder will exercise his right to buy this lot of shares on expiration if the underlying share price appreciates.

To obtain the call option from the option seller, the buyer must pay a fee or option premium. The price determined in the contract for the shares is called the strike price. The call option holder makes a profit when the strike price of the contract is lower than the stock price in the open market on expiration. The trader’s realised profit is the difference between spot and strike prices.

A call option can be ITM (in-the-money) or OTM (out-of-the-money) depending on whether the market price is above or below the strike price of the contract and the contract’s intrinsic value. The intrinsic value of the call option represents the value to the buyer and the cost to the seller. An in-the-money contract will only have intrinsic value on expiration.

How to Calculate Call Option Payoffs?

Let’s understand how the payoff of a call option is calculated. The payoff refers to the profit or loss that buyers and sellers make. The payoff of an option trade can be determined using three key variables: strike price, option premium, and expiration date. In a basic position, the losses for the buyer are limited to the premium paid. However, the profit can be unlimited. Conversely, the profit for the seller is limited to the premium received but the potential downside is unlimited.

Let’s understand with the help of an example. You purchased the call option for a ₹50 premium. The strike price of the option is ₹200. If the stock price reaches above ₹300, you will exercise your rights.

The payoff is calculated using the formula below.

Payoff = Spot price - Strike price

Profit = Payoff- Premium

If you are a seller of a call option potential for profit is limited to the premium. However, the possible loss is unlimited. The payoff and profit for a seller will look as follows:

Payoff = Spot price - Strike price

Profit/loss = Payoff + Premium paid

Call Option Example:

In the example below, the stocks of Reliance Industries are currently priced at ₹1953 and we have a call option of ₹2000 expiring on 31st December 2020. The contract is priced at ₹57.15. 1 lot of Reliance shares is 505 shares.

Spot price: ₹1953.15

Strike price: ₹2000

Option premium: ₹57.15

Expiry date: 31st December 2020

Lot size: 501 shares

You shall buy this contract if you believe that the stock price of reliance will increase to ₹2000 in the time to come. If that happens, the seller will be obligated to sell the shares at the strike price (or cash settle the difference). However, if that doesn't happen, then, you will lose the premium.

You can cancel the contract in this case, the reason behind this is that you can buy the stocks from the market at a cheaper rate than the seller’s rates.

What Is a Put Option?

Put options are financial contracts that provide the holder with the right, but not the obligation, to sell a specified quantity of underlying securities, like stocks, at a predetermined price within a set time frame. Traders use put options to profit from declining asset prices or to hedge against potential losses. Put options are used for risk management and speculative purposes.

How Do Put Options Work?

Traders use put options for hedging and speculating in a bear market when the asset price is expected to decline. The premium of a put option increases with a declining underlying stock price. Alternatively, if the stock price increases, the put option premium declines.

Put options give the option holders the right (non-obligatory) to sell the underlying stocks when the stock price declines. In the market, traders would buy put options to safeguard against declining stock price.

How to Calculate Put Option Payoffs?

The buyer of a put option makes a significant profit when the underlying stock price moves below the option strike price. In a nutshell, the lower the stock price moves below the option strike price, the higher the profit. But if the stock price moves upward, the buyer will let the contract expire. In this case, the loss incurred is the premium paid to the seller.

For the put option seller, the profit is limited to the premium received. However, the potential downside is the strike price minus the premium.

Put Option Example:

In the above example,

Strike price: ₹1953.15

Spot price: ₹1900

Option premium: ₹46.30

Expiry date: 30th December 2020

Lot size 505 shares

Options In Other Countries

US Options Contracts: They can be exercised at any point in time till the date of expiry.

European contracts: They can be exercised only on the date of expiration.

Basic Terms

Strike Price: Price at which buying or selling of an asset takes place before the expiration date.

Spot Price: Price of the asset in the stock market at the moment.

Options Expiry: The date on which the contract expires, is the last Thursday of the month.

Option Premium: The amount paid by the option buyer to the option seller at the time of buying the option.

Settlement: Option contracts are settled via cash in India for indices, while stock options are settled with exchange of shares.

Types of Strike Price Call & Put Options

For any underlying asset, traders have the option to purchase the various types of options - OTM (Out of the Money), ATM (At the Money) and ITM (In the Money) based on their outlook about the market.

Out-of-the-Money (OTM) options are options that have no intrinsic value but carry the potential for profit if the direction of the market move is in your favour.

At-the-Money (ATM) options are nearest to the prevailing market price and balance risk and reward.

In-the-Money (ITM) options are options which already have intrinsic value; thus, they are more expensive but more secure.

For instance, when NIFTY is trading at ₹20,000, here are the types of options that you can purchase:

For Call and Put Option:

(CE):

₹20,000 CE (At-the-Money)

Below ₹20,000 CE, like ₹19,800 (In-the-Money)

Above ₹20,000 CE, like ₹20,200 (Out-of-the-Money)

(PE):

₹20,000 PE (At-the-Money)

Above ₹20,000 PE, like ₹20,100 (In-the-Money)

Below ₹20,000 PE, like ₹19,900 (Out-of-the-Money)

The choice of the right one impacts profitability and overall risk exposures.

There are some important terms that should be understood when trading call options and put options.

Intrinsic Value

It is the variation between the price of the underlying asset and the strike price. Only an "in-the-money" option has intrinsic value, while "out-of-the-money" or "at-the-money" options have zero intrinsic value.

Time Value

This is the additional amount that is paid over and above the intrinsic value, and it is the potential gains which can be achieved before the expiration date.

Premium

The premium is the total cost of the option, and it is calculated as Intrinsic Value + Time Value. The premium paid for a call option is the maximum loss a trader can incur, and similarly, the premium for a put option represents the maximum potential loss for the buyer.

Theta

Theta quantifies the rate of loss of value when an option gets closer to its expiration.

Time/Theta Decay

Time decay is the slow decline in the value of an option as the expiration of the option gets closer.

Difference Between Call Option and Put Option

Parameters	Call option	Put option
Definition	Gives the buyer the right but not the obligation to buy	Gives sellers the right but not the obligation to sell an asset.
Investor Expectation	The stock prices will increase.	The stock prices will fall.
Gains	The gains are unlimited for the buyer.	Limited gains as the stock prices cannot fall to zero.
Loss	Loss is limited to the premium paid.	The loss will be strike price minus the premium.
Reaction to dividend	Lose value	Gain value

Call option- Expiry (Buying)

Three things can happen as the call option nears expiry-

Market price > Strike price = In the money call option = gains

Market Price < Strike Price = Out of Money call option = Loss

Market Price = Strike Price = At the Money call option = Break – Even

Call option- Expiry (Selling)

When you sell a call option, three things can happen as it nears expiry-

Market Price > Strike Price = In the Money call option = Loss

Market Price < Strike Price = Out of Money call option = Gains

Market Price = Strike Price = At the Money call option = Profit in the form of premium.

Put option Expiry (Buying)

When you buy a put option, three outcomes are possible-

Market Price > Strike Price = Out of Money put option = Loss

Market Price < Strike Price = In the Money put option = Gain

Market Price = Strike Price = At the Money call option = Loss of premium paid.

Put Option (Selling)

When you sell a put option, three outcomes are possible-

Market Price > Strike Price = Out of Money put option = Gains

Market Price < Strike Price = In the Money put option = Loss

Market Price = Strike Price = At the Money call option = Profit in the form of premium.

Risks and Rewards In The Two Options

	Call Buyer	Call Seller	Put Buyer	Put Seller
Maximum Profit	Unlimited	Premium received	Strike price minus premium	Premium
Maximum Loss	Premium paid	Unlimited	Premium Paid	Strike price- premium
No profit or loss	Strike price + premium	Strike price + premium	Strike price- premium	Strike price- premium
Ideal Action	Exercise	Expire	Exercise	Expire

These basics may help you understand the concepts, but navigating the market is a different process altogether. You require extensive knowledge and practice before that. So, do ensure that you weigh all the profits and risks before making an investment in the market.

Common Questions Regarding Options

What are the advantages of buying options?

There are a number of benefits to purchasing options, whether for trading or hedging reasons. One of the main ones is that they give investors the opportunity to gain exposure to a stock at a fraction of the price. For example, if a stock is trading at Rs. 12,000, you can have control over the stock by buying a contract for only Rs. 130 Rs - Rs. 150, depending on the strike price and date of expiry.

Buying options has the following important benefits:

Cost Efficiency: You can play along with price movements of expensive stocks without having to pay for the full value of the stocks.

Leverage: Because of the leverage possible in options, even small moves in stock price may produce large amounts of profit.

Hedging Capability: Investors can buy put option contracts to hedge for potential losses in their portfolio.

Flexibility: Options can be applied to speculations as well as risk management strategies.

Limited Risk: Maximum loss is limited to the premium paid for the option.

For instance, if you have shares in HDFC Bank and you are expecting a fall, then you can buy put option contracts to take protection from losses. If the stock drops, you can cover the decline in the share value with the profitability from the put option, hence presenting an intelligent and flexible risk management strategy.

Conclusion

In conclusion, knowing the basics of call and put option trading can benefit investors in making more informed and strategic decisions. These tools provide flexibility and therefore traders can take advantage of both rising markets and falling markets and manage their risk exposures effectively.However success in options trading needs to have the proper knowledge, patience and timing. By gaining an understanding of the functionality of call and put option contracts, investors can utilise them to maximise profits, hedge current investments and also diversify their investment portfolio with confidence.