In today’s world of finance and investment, options are the tools that allow investors to assume the future price fluctuations of various assets, such as stocks, indices, and commodities. Two commonly used options are: the call option and the put option.
For anyone who wants to learn options trading, the first thing they should know is the difference between a call and a put option. If you want to make informed decisions regarding options trading, then it is important to know the key differences between call and put options.
This article will discuss the put and call options as well as the difference between the call and put options.
What is a call option?
Call options give the holder the right to buy an underlying asset at a predetermined (strike) price before the expiration date. If at this point the stock price rises, then the trader will buy at the strike price, which is buying the shares at a lower price and selling them to earn profits. With the call option, you can calculate your profit or loss by subtracting the current price from the breakeven point.
For example: suppose you are buying the shares of XYZ Company, which is currently trading at Rs. 200 per share. You are assuming the price will increase in the next two months. To gain profit, you buy a call option at the anticipated price (strike price = 250) with a premium of Rs. 10 for the expiration of two months.
Now, if the stock price increases to Rs. 300, you can use your call option. You can buy the share at the price of Rs. 250, which is in your call option contract, and sell it in the market at the current price of Rs. 300, gaining profits. Therefore, you get the profit of Rs. 50 (300–250) minus the premium of Rs. 10 you paid. So the net profit is (50−10) Rs. 40.
However, if the stock price goes down to Rs. 150, you will have to bear the loss of Rs. 50 plus the price of the premium of Rs. 10.
What is a put option?
The put option gives the holder the right to sell an underlying asset at a predetermined price before the expiration date. If at some point the stock price goes down, then the holder will sell the stock at a specified price, which means selling the share at a higher price and earning profits.
For example: suppose you are selling the shares of ABC Company, which is currently trading at Rs. 300 per share. You are assuming the price will go down in the next 3 months. To gain profit, you buy a put option at the anticipated price (strike price = 250) with a premium of Rs. 10 for the expiration of three months.
Now, if the stock price goes down to Rs. 200, you can use your put option. You can sell the share at the price of Rs. 250 using your put option contract and sell in the market for a higher price than the current price of Rs. 200. Therefore, you get the profit of Rs. 50 (250-200), minus the premium of Rs. 10 you paid. So the net profit is (50−10) Rs. 40.
However, if the stock price increases to Rs. 350, you will bear the loss of Rs. 50 plus the price of the premium of Rs. 10.
Differences between Call and Put Options
| Call Option | Put Option |
| It gives the holder the right to buy a share at a predetermined price before the expiration date. | It gives the holder the right to sell a share at a predetermined price before the expiration date. |
| Investors who expect prices to rise (bullish) use this option. | Investors who expect the prices to drop (bearish) use this option. |
| There’s a certainty of unlimited profits as the price of an underlying asset can increase significantly. | There’s a possibility of unlimited profits if the price of an underlying asset can stoop low. |
| The maximum loss you bear is the premium amount you paid for the call option. | The maximum loss you bear is the premium amount you paid for the put option. |
| It can be considered a security deposit, allowing you to buy a product at a specified price. | It acts like insurance that offers you protection against the loss. |
Conclusion
Trading in futures and options can definitely provide a profitable path for many traders. After understanding the difference between a call and put option, it will help you make informed decisions and avoid risk successfully in the financial market.
Both of these options can earn you profits if you carefully consider the limited risks and expiration dates. As with any investment, it’s essential to do thorough research and consult professionals if necessary.
Get access to market news, updates and trends; follow our telegram channel @onlinetradinginstitute
| Disclaimer: The sole purpose of our financial articles is to provide you with educational and informative content. The content in these articles does not intend any investment, financial, legal, tax, or any other advice. It should not be used as a substitute for professional advice or assistance. |