Understanding Call And Put Options

Financial markets offer various instruments that go beyond simply buying or selling shares — and derivatives are one of these. A derivative is a financial contract whose value is derived from an underlying asset, such as a stock, index, commodity, or currency.

Among the most common derivatives are futures and options, which allow investors to potentially hedge risks, earn returns, or speculate on price movements.

Within this space, call and put options form the foundation of options trading. These contracts give investors the flexibility to buy or sell an underlying asset at a predetermined price within a specified period. In this article, we explain what call and put options are, how they work, the potential outcomes for buyers and sellers, and key terms every options trader or investor should understand.

Table of contents

• What is a call option?
• How does call option work?
• Example of a call option
• What is a put option?
• How do put options work?
• Example of a put option
• Difference between a call option and a put option
• Basic terms relating to put and call options
• How to calculate call options and put option payoffs
• Risk vs reward - call option and put option
• What happens to call options on expiry - buying a call option
• What happens to call options on expiry - selling a call option
• What happens to put options on expiry - buying a put option
• What happens to put options on expiry - selling a put option

What is a call option?

A call option gives the buyer the right, but not the obligation, to purchase an underlying asset at a predetermined strike price on or before the expiry date. The buyer pays a premium to acquire this right, while the seller (called the writer) receives the premium and assumes the obligation to sell if the buyer exercises the option. Call options may be suitable for investors who expect prices to rise.

How does call option work?

If the market price of the underlying asset rises above the strike price, the call buyer can exercise the option to buy at the lower strike price and potentially sell at the higher market price, earning a profit equal to the difference between market and strike price minus the premium paid (before accounting for transaction costs, taxes, and other fees which will reduce actual returns). If the market price stays below or equal to the strike price, the buyer typically lets the option expire worthless, losing only the premium paid. In that case, the seller keeps the premium as profit.

Read Also: Futures and Options Trading: Meaning, Types and Example

Example of a call option

Suppose you buy a call option on stock ABC with a strike price of Rs. 150, premium Rs. 8, and lot size 100.

If at expiry ABC trades at Rs. 170, the rise in intrinsic value per share is Rs. 20 and potential profit per share is Rs. 20 – Rs. 8 = Rs. 12.

Total potential profit = Rs. 12 × 100 = Rs. 1,200.

If ABC closes at Rs. 140, the option expires without value, and the loss equals the premium paid = Rs. 8 × 100 = Rs. 800.

Thus, the call buyer benefits only if the price exceeds the breakeven point (strike + premium).

Example for illustrative purposes only.

What is a put option?

A put option gives the buyer the right, but not the obligation, to sell the underlying asset at the strike price on or before expiry. Buyers of puts may use them to cushion against price declines or to potentially benefit from falling markets. Sellers receive the premium as income but take on the obligation to buy the underlying asset if exercised. Traders may buy a put if they expect prices to decline.

How do put options work?

If the market price falls below the strike price, the put buyer can sell at the strike and realise a potential gain equal to the difference minus the premium paid. If the market price stays above or equal to the strike, the buyer loses the premium. The seller retains the premium unless the price declines, in which case they may face losses when required to buy the asset at a higher price.

Example of a put option

If you buy a put on stock XYZ with a strike price of Rs. 200, premium Rs. 6, and lot size 100, and at expiry XYZ trades at Rs. 160, the rise in intrinsic value is Rs. 40 per share.

Potential profit per share = Rs. 40 – Rs. 6 = Rs. 34.

Total potential profit = Rs. 34 × 100 = Rs. 3,400.

If XYZ remains above Rs. 200, the put expires without value, and the loss equals the premium paid.

Example for illustrative purposes only.

Difference between a call option and a put option

• A call option provides the right to buy the underlying asset, while a put option provides the right to sell it.
• Buyers of calls may benefit from price increases; buyers of puts may benefit from price declines.
• Buyers of puts may benefit from price declines but similarly risk losing the entire premium if prices don't fall sufficiently
• Call writers have an obligation to sell if exercised, while put writers have an obligation to buy.

Read Also: Can Mutual Funds Invest in Options and Futures?

Basic terms relating to put and call options

• Spot price: The current market price of the underlying asset.
• Strike price: The agreed price at which the underlying can be bought (call) or sold (put) when the option is exercised.
• Option premium: The cost paid by the buyer to the seller to enter the option contract.
• Option expiry: The date by which the option can be exercised before it becomes invalid.
• Settlement: The process of completing the contract through cash or asset settlement as per exchange rules.

How to calculate call options and put option payoffs

Risk vs reward - call option and put option

What happens to call options on expiry - buying a call option

• If market price is below the strike price, the option expires without value, and the buyer loses the premium.
• If market price is above the strike price, the buyer realises a potential profit.
• If market price equals the strike price, the option expires at-the-money with no intrinsic value.

What happens to call options on expiry - selling a call option

• If market price is below the strike price, the seller retains the premium as profit.
• If market price is above the strike price, the seller incurs a potential loss.
• If market price equals the strike price, the seller keeps the premium.

What happens to put options on expiry - buying a put option

• If market price is above the strike price, the option expires without value.
• If market price is below the strike price, the buyer realises a potential profit.
• If market price equals the strike price, the option expires at-the-money with no intrinsic value, and the buyer loses the premium paid.

What happens to put options on expiry - selling a put option

• If market price is above the strike price, the seller keeps the premium as profit.
• If market price is below the strike price, the seller incurs a potential loss.
• If market price equals the strike price, the seller retains the premium.

Read Also: 16 Options Trading Strategies for Traders

Note: Derivatives trading involves substantial risk of loss and is not suitable for all investors. Options trading entails significant risk and is not appropriate for all investors. Prior to trading options, you should fully understand the risks involved. Past performance may or may not be sustained in future. Investors should consider their investment objectives, risks, charges, and expenses before investing.

FAQs

What is a call and put in trading?

A call gives the purchaser the right to buy an underlying asset at a pre-agreed strike price, while a put gives the purchaser the right to sell it. Buyers pay a premium; writers receive the premium and accept contractual obligations.

What is a call option in the share market?

A call option on a share allows its buyer to acquire the underlying share at the strike price on or before expiry, in exchange for a premium payment.

Is it better to buy calls or puts?

Neither is universally better. Calls may be suitable when expecting potential price appreciation, while puts may be suitable for protection against downside moves. The decision depends on the investor’s outlook, time horizon, risk appetite, and available capital.

What is an example of a put option?

Buying a put with a strike price of Rs. 200 and a premium of Rs. 6 on 100 shares may yield potential profit if the underlying falls below Rs. 194 (strike minus premium). At Rs. 160, the intrinsic value would be Rs. 40 per share.

What is an example of a call option?

Buying a call with a strike price of Rs. 150 and a premium of Rs. 8 on 100 shares may yield potential profit if the underlying rises above Rs. 158 (strike plus premium). At Rs. 170, the potential profit would be (Rs. 170 – Rs. 150 – Rs. 8) × 100 = Rs. 1,200.

Examples for illustrative purposes only.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully.

This document should not be treated as endorsement of the views/opinions or as investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document is for information purpose only and should not be construed as a promise on minimum returns or safeguard of capital. This document alone is not sufficient and should not be used for the development or implementation of an investment strategy. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision. Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. This information is subject to change without any prior notice.

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