Call Options Vs Put Options

The terminologies of call and put are associated with the option contracts. An option contract is a form of a contract or a provision which allows the option holder the right but not an obligation to execute a specific transaction with the counterparty (option issuer or option writer) as per the terms and conditions stated. An option is considered as a derivative contract since its value is derived from an underlying security.

A call option is a contract for the future to buy the underlying asset in which the price is fixed today, whereas a put option is a contract for the future to sell the underlying asset in which too the price is fixed today. Both provide flexibility to investors to participate in the direction of the anticipated price movement, even though thy both come with some risk.

• A call option gives the holder the right, but not the obligation, to buy an underlying asset at a specified price (strike price) within a specific period (expiration date). 
• A put option gives the holder the right, but not the obligation, to sell an underlying asset at a specified price (strike price) within a specific period (expiration date). 
• With a call option, the investor profits when the underlying asset's price rises above the strike price. Conversely, with a put option, the investor profits when the underlying asset's price falls below the strike price. 

The call option vs put option explains the two different types of financial derivative terms in the option market. Both of them are frequently used by traders and investors for earning profits from the derivative market and at the same time miigating or protecting their invested funds from possible downside risk.

The key difference between these two types of concepts are that the call option gives the right to purchase the asset and the put option gives the right to sell the underlying asset.

Entering into a call-or-put option is an entire game of speculation. Suppose one trusts the movement of the underlying asset's price and is ready to invest some money with an appetite to bear the risk of a premium amount. In that case, the gains can be substantially significant. In terms of the Indian options market, a contract expires on the last Thursday of the month before which the agreement should be executed. Else contracts can be allowed to expire worthless with the premium amount foregone.

Thus, it entirely depends on the risk appetite of the investor and the faith in the direction of the price movement of the underlying asset for which the option contract is undertaken. Call and put options are opposite terms; a combination of speculation and financial ability will help extract maximum financial gains.

Both the concepts are very complex and involves a lot of risk for the traders. Thus, it is extremely necessary to understand the mechanics in detail before engaging in trading in them. It is always better to take advice from financial professionals who will conduct proper research and then take informed decisions.

Let us look at the following graphs to understand the difference between call and put option payoffs. These graphs let traders visualize an option’s value upon expiry on the basis of the underlying asset.

First, let us look at a call option payoff graph.

The profit or loss generated by buyers of call options is dependent of the underlying asset. In case the spot price is more than the strike price, buyers make financial gains. That said, if the strike price is more than the spot price, buyers let their option expire unexercised. Additionally. In this case, the overall loss cannot exceed the premium paid for purchasing the option. 

The put option pay off graph below shows the profit or loss generated from the option upon expiry. Moreover, it shows the transaction’s break-even point. Thus, in short, it provides a diagrammatic representation of the potential results concerning the action of purchasing a put.

In case individuals purchase a put option, they will hope that the underlying asset’s price decreases as the more it drops compared to the strike price, the higher the profit they’ll make. Thus, simply put. If individuals take a long put position, they will make gains if the underlying asset’s price drops, whereas they will lose money in case the price rises.

The call option vs put option simple example given below will help in clarifying the idea.

Let us assume that Mike wants to trade in the options market of ABC Inc., whose stock is currently trading at $100.

Call Option

Mike believes that within the coming weeks the stock price has the potential to go up.

He decides to buy a call option with a strike price of $110 which will expire within a month from now. Therefore, he has the right to buy 200 shares of the company at $110 on or before expiration date. If the price goes up to suppose $120, he still buys them at $115 by exercising the option contact, and later sell them at $120, earning a profit of $10 per share, which comes to a total gain of $2000. However, if the price goes down, he lets the call option expire and his loss is limited to the premium that he has paid.

Put Option

Mike believes that within the coming weeks, the stock price may go down.

He decides to buy a put option with a strike price of $90 which will expire within a month from now. Therefore, he has the right to sell 200 shares of the company at $80 on or before expiration date. If the price goes down to suppose $80, he still sell them at $90 by exercising the option contact, and later buy them at $80, earning a profit of $10 per share, which comes to a total gain of $2000. However, if the price goes up, he lets the put option expire, and his loss is limited to the premium that he has paid.

The above call option vs put option simple example explains the concept in detail for proper understanding.

Given below are some basic differences between the two financial concepts. Let us try to understand them in detail.

1. The buyer of a call option has the right but is not necessarily obligated to buy a pre-decided quantity at a certain futuristic date (expiration date) for a certain strike price. Conversely, put options will empower the buyer with the right to sell the underlying security for the strike price at a futuristic date for a predetermined quantity. However, they are not obligated for the same.
2. A call option permits the buying of an option, whereas a put will permit the selling of an option.
3. The call option generates money when the value of the underlying asset is rising upwards, whereas the put option will extract money when the value of the underlying is falling.
4. As a continuation of the above, the potential gain in a call option is unlimited due to no mathematical limitation in the rising price of any underlying, whereas the potential gain in a put option will mathematically be restricted.
5. Despite being bound by a single contract, the investor of a call option will look for a rise in the price of a security. Conversely, in the put option, the investor expects the stock price to fall down.
6. Both options can be In the Money or Out of the Money. In the case of the call option, the underlying asset price is above the strike price of the call. Out of the money indicates the underlying asset price is below the call strike price. Another aspect is ‘At the Money,’ meaning strike price and underlying asset price are the same. The premium amount will be higher for the ‘In the Money option’ since it has an intrinsic value whilst the premium is lower for Out of the Money call options.
7. With respect to put options, In the Money indicates underlying asset price below the strike price. Out of the Money is when the underlying asset price is above the put price. The premium amount for the ‘In the Money’ option will be higher but the expectation of ‘in the money’ is opposite to what it was in the call option.
8. Buying a call option requires the buyer to pay a premium to the seller of the call option. However, no margin has to be deposited with the stock exchange. However, selling a put requires the seller to deposit margin money with the stock exchangeOption Trading Strategies.

The table given below compares both the types of options for better understanding.

This has been a guide to what is Call Options Vs Put Options. We explain it with differences between them with example, infographics & comparative table. You may have a look at below suggested readings to enhance your knowledge of derivatives.

• Put OptionExamples
• Forwards vs. Futures - Difference
• Put-Call Parity