Call and Put Option

Call and put options are two kinds of options available in the stock market. You can exercise a call option when you expect an increase in the stock price while using a put option when you expect a decrease in the stock price.

Let us know more about the call and put option in detail.

Options Contracts

An options contract gives the buyer the right to buy an underlying asset but it is not an obligation to buy. It gets value from the value of the underlying asset and it has no value of its own. A stock, currency, or commodity can be the underlying asset. Within the stipulated period mentioned in the contract, the buyer can keep or cancel the option contract.

What is call option?

The call option gives the buyer the right but not the obligation to buy the asset at a particular price before the expiration date of the contract.

How Do Call Options Work?

The buyer first pays a fee or option premium to obtain the call option from the option seller. The strike price is the predetermined price in the contract for the shares. If the strike price is lower than the stock price in the open market on expiration, the call option holder makes a profit. The trader's profit lies in the difference between spot and strike prices.

What is put option?

 The put option gives the buyer the right but not the obligation to sell the asset at a particular price before the expiration date of the contract.

How Do Put Options Work?

When the asset price is expected to decline, traders use put options. With a declining underlying stock price, the premium of a put option increases. On the other hand, the put option premium declines, if the stock price increases. With the put option, you have the right to sell the underlying stocks when the stock prices decline.

Basic Terms Relating To Call and Put Option

Below are the basic terms related to call and put option:

• Strike Price:  The price at which an asset is bought or sold prior to the expiration date.
• Spot Price: The current price of the asset at that moment in the stock market.
• Options Expiry: The contract expires on the last Thursday of the month.
• Option Premium: At the time of buying the option, the amount paid by the option buyer to the option seller.
• Settlement: When the option contracts are settled in cash.

What is the Difference between Call Option & Put Option?

How to Calculate Call Option Payoffs?

The profit or loss made by an option buyer or seller is termed the call option payoff. Expiry date, strike price, and premium are the three distinctive variables for evaluating call options. These variables are used for calculating the payoff generated from call options. 

Payoffs for Call Option Buyers

By using the following formulas, the payoff and profit amount are calculated:

• Payoff = Spot Price - Strike Price
• Profit = Payoff - Premium Paid 

Payoff for Call Option Sellers

By using the following formulas, the payoffs and profit amount for sellers are calculated:

• Payoff = Spot Price - Strike Price
• Profit = Payoff + Premium Paid

How to Calculate Put Option Payoffs? 

The put option payoffs depend on two options the amount paid for the option in the beginning and the things you are likely to receive while exercising it. You can earn a profit when the underlying price falls lower than the strike price.

Payoffs for Put Option Buyers

The put option gives the buyer the right but not the obligation to sell the asset at a particular price before the expiration date of the contract. If the spot price is below the strike price during expiry, the buyer can make a profit.  

On the other hand, if the underlying spot price is greater than the strike price, then the buyer enables his option to expire. In this case, the loss of the buyer is the premium paid for buying the put option.

Payoffs for Put Option Sellers

The sellers charge a premium amount when it comes to selling the put option. Depending on the spot price of the underlying, the profit or loss of the buyer on the put option is decided. The buyer’s profit in the put option is the seller’s loss.

The put option will be exercised on the seller if the spot price is lower than the strike price during expiry. If the buyer is enabled to exercise the option un-exercised while the seller keeps the premium amount.

Risk vs Reward—Call Option and Put Option

What Happens to Call Options on Expiry? Buying Call Option: 

In call and put options, when you buy a call option, a few things can happen during expiry:

• Market Cost/Price < Strike Cost/Price = Out of Money call option = Loss
• Market Price > Strike Price = In the Money call option = Gains/Profits
• Market Price = Strike Price = At the Money call option = Break – Even (Zero profit, zero loss)

What Happens to Call Options on Expiry? Selling Call Option:

In call and put options, when you sell a call option, certain things are likely to happen upon expiry:

• Market Price < Strike Price = Out of Money call option = Gains/Profits
• Market Price > Strike Price = In the Money call option = Loss
• Market Price = Strike Price = At the Money call option = Profit in the form of premium

What Happens to Put Options on Expiry? Buying Put Option:

In call option and put option, when you buy a put option, several things are likely to happen during expiry:

• Market Price < Strike Price = In the Money put option = Gain / Profits
• Market Price > Strike Price = Out of Money put option = Loss
• Market Price = Strike Price = At the Money call option = Loss of premium paid

What Happens to Put Options on Expiry? Selling Put Option:

In call option and put option, whenever you sell a put option, a few things can probably happen during expiry:

• Market Price < Strike Price = In the Money put option = Loss
  Market Price > Strike Price = Out of Money put option = Gains / Profits
  Market Price = Strike Price = At the Money call option = Profit in the form of premium