What are the call options and put options in the stock market?

The two primary options available in the derivatives market are call options and put options. In situations where you anticipate a rise in prices, a call option is employed. When you anticipate a decline or fall in price, you would utilise a put option. In order to use options to make money, we must first understand their fundamentals. In this post, we’ll
go over the fundamentals of options, such as what call options and put options are, as well as call and put option examples and simplified puts and calls for newcomers.

Let’s start.

What is call options (CE)?

A call option is a specific kind of options contract that grants the owner the right—but not the obligation—to purchase a securities or other financial instrument at a given price (or the option’s strike price) within a given time frame.

An option premium must be paid in order to purchase a call option. As previously stated, the decision to use this option rests solely with the owner. If he decides it is not lucrative, he can let the option expire. On the other hand, the seller is required to sell the securities that the buyer wants. While the earnings in a call option can be unlimited, the losses are restricted to the option premium.

Call and Put Options Basics for Beginner

The underlying asset’s value	Things to do
Anticipated to rise	BUY Call Option or SELL Put Option
Anticipated to fall	BUY Put Option or SELL Call Option

When options were first introduced in India, there were two different types: European options and American options. The stock options were American in nature whereas all index options (Nifty, Bank Nifty options) were of a European origin. The key area of distinction between the two was “Options exercise.”

European Options- If an option is of the European kind, the option buyer will be required to wait until the option expires before exercising his right. The settlement is determined by the spot market price on the day of expiration.

American Options- During the period before the option expires, the option buyer may exercise his right to purchase the option anytime he sees fit. The payment depends on the spot market at that exact time rather than really on expiry.

Later NSE made the decision to fully remove American Option from the derivatives market. As a result, all options in India are now of a European nature, allowing the buyer to exercise it depending on the spot price on the expiration date.

How does Option Buying work:

Let’s take the case of Avinash and Karan again, But now they are making a contract based on the Stock Market.

Avinash is actively weighing the possibility of buying Shares of ABC Company. The worth of one share is Rs. 1800. Avinash has been advised that the company is going to report remarkable profit margins in the upcoming quarterly financial result due to better business in past months and the share price will rise to Rs 2000. Whereas, Karan anticipate that the ABC company’s upcoming quarterly result wouldn’t be that good, so he is not bullish on the stock price and expects the share will fall to Rs 1700.

When to buy the call option: If you expect the price of the Company to increase.

When to buy the Put option: If you expect the price of the Company to fall in upcoming days.

In this case, Avinash buys a call Option (CE) and Karan buys Put option(PE) Both Avinash and Karna don’t need to make arrangements themselves like in case of land. In Stock Market, there is already a regulated derivatives market which helps to carry out such contracts easily. The specifics of the agreement are as follows:

For Avinash (Call Option Buyer),

Spot price (Current Market Price) – Rs 1,800

Strike price – Rs 2,000

Option premium – Rs 50

Expiry – 28th July 2022

Lot Size – 500 shares

For Karan (Put Option Buyer)

Spot price – Rs 1,800

Strike price – Rs 1,700

Option premium – Rs 40

Expiry – 28th July 2022

Lot Size – 500 shares

After starting this deal, Avinash and Karan must now wait to find out what will truly occur. It is obvious that the share price of the land will change depending on how the company result turns out. However, there are only two scenarios that might occur regardless of what happens to the highway:

● The share price of the ABC Company would increase once the financial result comes out, maybe soaring to Rs. 2000.
● People are dissatisfied when the company reports weak financial results and the price of land drops to, say, Rs. 1700.

Let’s see what happens in each Scenario

Scenario 1-

The share price of ABC Company has increased since the company reported good profit margins in quaterly financial result announcement as Avinash had anticipated. Keep in mind that, according to the contract, Avinash has the right to terminate the relationship after(till expiry date). It is obvious that Avinash will benefit from the share
price dynamics.

The share is now being traded at Rs 2100. Avinash has the choice to exercise the call option and the seller is obligated to sell him 1 lot of ABC Comapny at Rs 1,800/share as you have paid him a premium of Rs 50, which binds him to the contract.

Avinash’s Profit statement would look like- ((2100 – 2000) – 50 (Premium))*500 =Rs 25,000.

But Karan would be in a loss as the actual situation is opposite to what he anticipated. Maximum loss that can happen is (premium paid x Lot size) i.e. 40*500 = Rs 20,000

Scenario 2-

It turns out that the financial result was bad, and nothing significant is truly anticipated to come of it. The share price drops to Rs. 1500 as a consequence. Avinash would be in loss as the share price moved opposite to his expectations, but Karan (Put option Buyer will be in profit).

Karan’s profit statement will look like (( 1700-1500) – 40 (Premium))* 500= Rs 80,000

The maximum loss that can happen for Avinash ( option buyer) is (Premium paid X Lot Size) i.e . 50*500 = Rs 25000

Call options are further categorised as

In the money call option: In this situation, the strike price of the call option is below the security’s current market value.

Out-of-the-money call option: A call option is deemed out-of-the-money if the strike price is higher than the security’s current market price.

Consider the above case where Avinash bought a call option at Strike price of 2000, while the stocks was trading at 1800 ). since the strike price of a call option is higher than the spot price, it is known as Out of the money call option.
If he had chosen a strike price of 1700 when the spot price is trading at 1800, it would have been an In the money call option.

What is Put options (PE)?

The right to sell underlying securities at a certain strike price within the expiration date is provided by put options to the option holder. This enables investors to set a minimum selling price for a certain investment. The option holder is not required to use the right in this instance either. He can sell the investment at market value and forego exercising the option if the market price is higher than the strike price.

Similar to call options, put options can also be separated into in-the-money and out-of-the-money categories. In the money put option: Put options whose strike price is higher than the current value of the underlying securities. Out-of-the-money put option: A put option is out of the money if the strike price is below the going rate.

What is the Difference Between Call Option & Put Option?

Parameters	Call Option (CE)	Put Option (PE)
Meaning	The buyer is given the right to buy, but not the obligation.	The buyer has the option to sell but is not obliged to do so when purchasing a put option.
Expectations of Investors	A call option buyer anticipates higher/rising stock prices.	A buyer of a put option anticipates a decline or reduction in stock prices.
Gains	The rewards are limitless for the buyer of a call option.	Gains for a put option buyer are constrained since stock prices won’t fall to zero.
Loss	A call option buyer’s loss is strictly capped to the premium they paid.	Maximum loss for a put option seller is premium paid

Risk vs Reward

	Call Buyer	Call Seller	Put Buyer	Put Seller
Maximum Profit	Unlimited	Premium Received	Strike Price – Premium	Premium Received
Maximum Loss	Premium Paid	Unlimited	Premium Paid	Strike Price – Premium
Neither Profit nor Loss	Strike price + premium	Strike price + premium	Strike price – premium	Strike price – premium
Ideal Action	Exercise	Expire	Exercise	Expire

 

Other complex trading techniques involve buying and selling calls and options in various combinations and at various strike prices. You may profit from practically every form of market activity by using options wisely.

The Options are derivatives that allow you to purchase or discharge the right to purchase or rid of equities at a certain price. While there is no danger involved in purchasing options, there is theoretically limitless risk involved in selling them. Consider this while deciding the kind of options to utilize in your investment plan and whether to purchase or sell options. Additionally, keep in mind that trading derivatives carry a higher risk than trading equities.

 

About the Author

Ketan Sonalkar (SEBI Rgn No INA000011255)

Ketan Sonalkar is a certified SEBI registered investment advisor and head of research at Univest. He is one of the finest financial trainers, with a track record of having trained more than 2000 people in offline and online models. He serves as a consultant advisor to leading fintech and financial data firms. He has over 15 years of working experience in the finance field. He runs Advisory Services for Direct Equities and Personal Finance Transformation.

Note – This channel is for educational and training purpose only & any stock mentioned here should not be taken as a tip/recommendation/advice

You may also like: Options trading strategies