Call and Put Options: Meaning, Types, Difference & Examples

Option trading begins with two important terms, Call and Put. These terms may seem technical at first, but these instruments are crucial in designing trading strategies to take advantage of different market situations. 

In this blog, we will analyze both these options in detail along with their meaning, differences and examples.

What is Call Option?

A call option is a contract that gives a holder the right to buy an underlying asset in the future at a predetermined price (called the strike price). It is important to note here that this is a “right”, not an “obligation” – that is, you can buy it if you want, and you can leave it if you don’t want it.

Suppose the price of a stock is ₹100 right now, and it is expected that it will rise to ₹120 until option contract expiry. In such a situation, buying a call option with a strike price of ₹100 gives the buyer the right to buy the stock for ₹ 100 – even if its market price increases to ₹120.

Traders usually buy a call option when they expect that the price of a stock will increase in the future. This creates the possibility of more profit with less investment.

What is a Put Option?

Put Option is a contract that gives the holder the right to sell an underlying asset in the future at a fixed price (called strike price). It means the holder can choose to exercise the option if it is profitable or let it expire worthless.

Suppose the price of a stock is currently ₹150, but it is estimated that it may fall to ₹120 in until the option contract expiry. In such a situation, buying a put option with a strike price of ₹150 gives the investor the right to sell that stock for ₹150, no matter how much the market price goes down.

Put options are especially useful when the market is moving towards recession or there is a fear of a stock price decline. By buying puts, the investor can protect his portfolio or make profit from falling prices.

In simple words, a put option is a means of both portfolio protection and potentially profit from falling prices.

Read Also: What is Put-Call Ratio?

Key Terms to Know About Call and Put Options

To be successful in option trading, it is important to understand certain terms. These terms strengthen the basic understanding of trading :

• Strike Price : The price at which the option holder gets the right to buy or sell shares.
• Premium: The amount paid to buy the option, which is the maximum amount of loss that can be incurred.
• Expiry Date: The date on which the option expires.
• Intrinsic Value: The difference between strike price and the underlying asset’s price at expiry.
• Time Decay or Theta: The decrease in the value of the option due to time.

Call and Put Options with Examples

Call Option Example: When the market is expected to rise

Scenario : Nifty is currently trading at 24,700 and it is expected that it may move higher in a few days.

Trade : Call Option with strike price of 24,900 bought at a premium of 100 points.

Case 1 – Profit on Expiry

If Nifty reaches 25,200 by expiry, then the option is termed as ITM and it would be profitable to exercise it:

• Intrinsic Value =  25,200 – 24,900 = 300 points
• Net Profit = ₹300 – ₹100 (premium) = 200 points per lot
• One point = ₹75 ; therefore, Net Profit = 200 * 75 = ₹15,000

Case 2  – Loss on Expiry

If Nifty declines or remains flat, the option will expire worthless. 

• Loss = 100 points (Premium)
• Net Loss = 100 * 75 = ₹7,500

Put Option Example: When the market is expected to fall

Scenario: Nifty is currently at 24,700, but it seems like it will fall.

Trade : Put Option with strike price of 24,500 bought at a premium of 90 points.

Case 1 – Profit on Expiry

If Nifty falls to 24,100 

• Intrinsic Value = 24,500 – 24,100 = 400 points per lot
• Net Profit = 400 – 90 = 310 per lot
• One point = ₹75 ; therefore, Net Profit = 310 * 75 = ₹23,250

Case 2 – Loss on Expiry

If Nifty moves higher or remains flat, the option expires worthless.

• Loss = 90 points (premium)
• Net Loss = 90 * 75 = ₹6,750

In Call and Put Options, the maximum loss is predetermined (limited to the premium), but if the market moves in the right direction, the returns can be manifold. This is also the biggest feature of option trading.

Read Also: What is Implied Volatility in Options Trading

ITM, ATM and OTM Call and Put Options

In option trading, just buying a call or a put is not enough. It is also important to understand the status of the option at that time – In-the-Money (ITM), At-the-Money (ATM) or Out-of-the-Money (OTM), as explained below:

1. In-the-Money (ITM)

A Call Option is ITM when the stock price is above the strike price. A Put Option is ITM when the price goes below the strike price.

• In Call Option : If the strike price is 24,500 and Nifty is currently trading at ₹24,700 Then the Call Option is ITM as it will give a profit if exercised immediately.
• In Put Option : If the strike price is ₹24,900 and Nifty is trading at 24,500 , then the Put Option is ITM as the market price is lower than strike price and exercising the put option will give a profit.

2. At-the-Money (ATM) 

When the current price and the strike price are approximately equal, the option is called an ATM.

For example:

• Strike Price = 24,500
• Nifty = 24,500 or around

In this case the intrinsic value of the option is almost zero. But the premium can be high as the asset price can move considerably till expiry. Both risk and opportunity are balanced in ATM options.

3. Out-of-the-Money (OTM) 

A Call Option is OTM when the current asset price is below the strike price, and a Put Option is OTM when the asset price is above the strike price.

• In Call Option: Strike price is 24,500 and Nifty is currently at 24,000.
• In Put Option: Strike price is 24,500 but Nifty is at 24,900.

Read Also: What is Spread Trading?

American vs European Options

In option trading, there are two types of options based on the exercise conditions:

• American Options : These types of options can be exercised on any day before expiry.
• European Options : Can be exercised only on the expiry day but can be traded on exchanges before expiry. In India, options are of European type.

The value, risk and profit of each option depends on whether it is ITM, ATM or OTM, and whether it is American or European. Choosing the correct option at the right time is the most important skill for a trader.

Key Differences Between Call and Put Options

Basis	Call Option	Put Option
Right	Right to purchase underlying asset at strike price	Right to sell underlying asset at a strike price
Buyer’s Expectation	The market price will go up	The market price will go down
Maximum Profit	Theoretically unlimited	Limited as asset price can fall to zero
Maximum Loss	The amount of premium (money paid to buy the option)	The amount of premium (money paid to buy the option)

Read Also: What are Option Greeks?

Advantages & Risks of Options Trading

Benefits of option trading

• Hedging: A strategy that uses options to protect against potential losses in bearish market conditions.
• Flexibility: Traders can profit from both bullish as well as bearish price movements using call and put options.
• Less capital required: Options trading require less capital than buying or selling an equivalent quantity of underlying asset.

Risks of option trading

• Loss of capital: The maximum loss is the premium paid for the option buyer, which can be lost completely. In case of option sellers, the losses can be significant.
• Time Decay: The value of the option decreases over time, which can lead to losses even if the market doesn’t move against your position.
• Complexity: It is not easy to understand the technical aspects of options, making them unsuitable for beginners.
• Market volatility: During periods of high volatility, the option premiums can fluctuate sharply.
• Timing: In option buying, losses occur if your judgement regarding market movement or timing is wrong, i.e. the expected movement must occur before expiry.

Understanding risk and reward is important

• Proper knowledge, timing, and strategy are very important for success in option trading.
• Trading without complete information can lead to financial losses.
• One should always learn ways to manage one’s risk so that losses can be limited.
• With the right research and learning, superior returns can be expected from option trading.

Read Also: Best Trading Apps in India

Pro Tips for Beginners in Options Trading

You can follow the below-mentioned tips to trade options profitably:

• Option Trading Tips for Beginners : To be successful in option trading, some basic but important things should be kept in mind. In the beginning, it is important to do paper trading to understand the market fluctuations. This helps in understanding the trading process, developing profitable strategies without investing real money.

• Importance of Risk Management : There is always a risk in option trading, so it is very important to learn risk management. Proper risk management helps avoid major losses.

• Use of options for hedging : Call and put options can be used for hedging. This means protecting your portfolio from the uncertainties of the market, so that sudden decline in portfolio value can be avoided.

By following these tips, the initial path of trading becomes easier and better decisions can be taken with experience.

Conclusion

Understanding call and put options before trading them is very important for any trader. Knowing the basics of these options and understanding their advantages and disadvantages is the key to success. It is very important to have technical knowledge and the right trading strategy before stepping into option trading. Only by mastering the basics, does the probability of earning profits in options trading increase. It is advised to consult a financial advisor before trading options.

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