13/01/2025
Series – III: Understanding Options – Call Option & Put Option
Volatility is an inevitable part of stock markets; it is arguably one of the most misunderstood concepts in investing. Investing is inherently about risk, but risk works both ways. Each trade carries with it the risk, both, of failure and of success.
Market volatility may provide numerous money-making opportunities for the patient & intelligent trader. This was one of the reasons of beginning of OPTIONS TRADING.
In this article, we will try to understand Options and their types and explore the factors that how one can take advantage of movements in stocks / Indices through option trading.
What are the OPTIONS?
Options are the derivatives instruments which gives the buyer the right, but not the obligation, to buy or sell an underlying asset at a specific price on or before a certain date.
Types of Options :
- CALL OPTION –
Option, which gives buyer a right to buy the underlying asset for a set price, at certain future date is called Call Option.
Call option generates money when value of the underlying asset is rising upwards.
- PUT OPTION –
Option, which gives buyer a right to sell the underlying asset for a set price, at certain future date is called Put Option.
Put option will extract money when value of underlying is falling.
How Options are different from futures
Future vs Options
A future is a right and an obligation to buy or sell an underlying stock (or other assets) at a predetermined price and deliverable at a predetermined time. Options are a right without an obligation to buy or sell equity or index. A call option is a right to buy while a put option is a right to sell.
Call Option Buy vs Future Buy
| Future Buy | Call Option Buy | |
| Payment | Required to pay margin | Required to pay premium only |
| Maximum Profit | Unlimited | Unlimited |
| Maximum Loss | Unlimited | Premium Paid |
| Profit Calculation (Before Expiry) | Future Current Price – Buying Price | Current Premium – Premium Paid |
| Profit Calculation (On Expiry) | Future Current Price – Buying Price | Spot Price – Strike Price – Premium Paid |
Put Option Buy vs Future Sell
| Future Buy | Call Option Buy | |
| Payment | Required to pay margin | Required to pay premium only |
| Maximum Profit | Unlimited | Unlimited |
| Maximum Loss | Unlimited | Premium Paid |
| Profit Calculation (Before Expiry) | Buying Price – Future Current Price | Current Premium – Premium Paid |
| Profit Calculation (On Expiry) | Buying Price – Future Current Price | Strike Price – Spot Price – Premium Paid |
Buyer vs Seller in Options
| Buyer | Seller |
| Pay Premium | Earn Premium |
| Max Profit – Unlimited | Max Profit – Premium Earned |
| Max Loss – Premium Paid | Max Loss – Unlimited |
| No Margin required | Full margin required |
| No Obligation | Obligation to buy or sell underlying assets. |
Conceptually Options are much broader topic and this article is just a brief of it.
In coming days we will make an effort to post more about options and how to hedge and build option strategies.