Call and Put Option Meaning?

Call and put options are derivative contracts that give traders the right, not the obligation, to purchase or sell an underlying asset at a certain price at a given time. A call option gives the right to purchase the asset, and a put option gives the right to sell it. The risk is limited to the option buyer, and the party that sells the option bears the liability in case the contract is exercised.These options are widely used to speculate price movements, hedge existing positions against market risk, and manage portfolio exposure efficiently without owning the underlying asset directly. This article explains what are calls and puts in options trading, how they work, call and put options examples and more.  

What is a Call Option and How Does It Work? 

A call option provides the trader the right to purchase an underlying asset at a pre-determined price. Unlike in futures, the trader is not obligated to purchase on or before a specific date. A call option is bought if the price of the underlying assets is assumed to rise. A call option can be bought as well as sold.  Here’s how a call option works: 

• The buyer buys a call option by paying the seller a premium amount.  
• The price at which the underlying asset can be purchased is known as the strike price. If the market price rises above the strike price before expiry, the option becomes profitable to exercise. 
• If the market price stays below the strike price, the option expires worthless, and the buyer’s loss is limited to the premium paid. 
• The seller earns the premium but faces unlimited loss potential if the asset price rises sharply. 

Example of Call Option  

Let’s say the shares of ITC Ltd. are currently trading in the market, and a trader is currently evaluating a call option contract. The contract details are as follows: 

• Spot Price: ₹452 
• Strike Price: ₹470 
• Option Premium: ₹12.80 per share 
• Expiry Date: 28th March 2025 
• Lot Size: 1,600 shares 

In this call option, the buyer is given the right, but not the obligation, to buy ITC shares at ₹470 on or before the expiry date by paying the option premium. Here are certain scenarios which might take place. 

Scenario 1: Stock price moves above the strike price 

If the ITC shares trade at ₹500 on expiry. Then the intrinsic value would be.  

Intrinsic Value per share = Spot Price − Strike Price 
= ₹500 − ₹470 = ₹30 

Profit per share = Intrinsic Value − Premium 
= ₹30 − ₹12.80 = ₹17.20 

Total Gains = ₹17.20 × 1,600 = ₹27,520 

The buyer makes a gain because the market price is significantly higher than the strike price. 

Scenario 2: Stock reaches the break-even point 

If ITC closes at ₹482.80, the trader will neither gain nor lose any capital. 

Break-even Price = Strike Price + Premium 
= ₹470 + ₹12.80 = ₹482.80 

Scenario 3: Stock price remains below the strike price 

If ITC closes at ₹460 on expiry. Then the option is not exercised, and the buyer might purchase shares directly from the market at a lower price. 

Maximum Loss = Premium Paid 
= ₹12.80 × 1,600 = ₹20,480 

What is a Put Option and How Does It Work? 

A put option gives the trader the right and not the obligation to sell the underlying asset at a specified price on or before the expiry date. A put option is purchased with the assumption that the price of the underlying asset will decrease. Similar to a call option, a put option can be purchased as well as sold. Here’s how a put option works: 

•  The buyer needs to first pay a premium to purchase the put option from the seller. 
• A strike price is the price at which the underlying asset can be sold. If the market price falls below the strike price before expiry, then the option becomes profitable to exercise. 
• If the market price stays above the strike price, then the option expires worthless. 
• The buyer’s maximum loss is limited to the premium paid. 
• The seller earns the premium but might face potential losses if the asset price declines sharply. 

Example of Put Option 

Let’s consider there is a trader who expects the share price of Tata Steel Ltd. to decline in the coming weeks and decides to buy a put option. Here are the contract details:  

• Spot Price: ₹720 
• Strike Price: ₹700 
• Option Premium: ₹18 per share 
• Expiry Date: 25th April 2025 
• Lot Size: 550 shares 

Here, the put option will give the buyer the right, but not the obligation, to sell Tata Steel shares at ₹700 on or before the expiry date by paying the option premium. Following are some scenarios that might take place.  

Scenario 1: Price falls below the strike price 

Let’s say the Tata Steel trades at ₹650 on expiry. Then the intrinsic value would be:  

Intrinsic Value per share = Strike Price − Spot Price 
= ₹700 − ₹650 = ₹50 

Gain per share = Intrinsic Value − Premium 
= ₹50 − ₹18 = ₹32 

Total Gains= ₹32 × 550 = ₹17,600 

The trader will make gains because the market price is significantly lower than the strike price. 

Scenario 2: Price reaches the break-even point 

Let’s say the stock price closes at ₹682. Then the trader neither makes a gain nor incurs a loss.   

Break-even Price = Strike Price − Premium 
= ₹700 − ₹18 = ₹682 

Scenario 3: Price stays above the strike price 

Assume Tata Steel closes at ₹710 on expiry. In this case, the option is not exercised. The trader might sell the shares directly in the market at a higher price. 

Maximum Loss = Premium Paid 
= ₹18 × 550 = ₹9,900 

After understanding the call and put option meaning along with examples, let’s understand the basic terms related to call and put option.  

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. 

How to Calculate Call Options and Put Option Payoffs?  

The table below shows how to calculate the call options and put options payoffs: 

Risk vs Reward - Call Option and Put Option 

The table below shows the risk and reward of call and put options in the share market. 

What Happens to Call Options on Expiry? 

The outcome of a call option on expiry depends on the relationship between the spot price and the strike price. The table below explains what happens to both buyers and sellers of call options under different expiry scenarios. 

What Happens to Put Options on Expiry? 

The outcome of a put option at expiry will be determined by whether the spot price is higher, lower or equal to the strike price. The result of buying and selling put options is described in the table below depending on various scenarios. 

Disclaimer: All investments are subject to market risks, economic conditions, regulatory changes, and other external factors. Returns are not guaranteed and may vary based on market performance and investment tenure. Investors should assess their risk tolerance and financial objectives, conduct their own research, and consult a qualified financial advisor before making any investment decisions. 

Conclusion 

Call and put options are considered attractive investment opportunities that also serve as high-leverage trading strategies. A call option allows traders to benefit from price appreciation, while a put option enables them to profit from price depreciation. Both are useful for speculating on rate movements or hedging costs. Equipped with knowledge of option pricing, payoffs, expiry results and risk–reward profiles, traders can place their trades based on market sentiment. With the right education and execution, options trading with a reputable online trading app can enhance portfolio flexibility and risk management in dynamic market conditions.