What Are Call and Put Options? How Are They Different?

Call Option and Put Option: An Overview

Many young traders are attracted to the future & Options because they assume that they can earn huge returns in a short period of time by trading in F&O and they don't need too much money. However, it comes with a lot of risks. So, it is important to understand what is put and call in the share market, the difference between the call and put option, how it works and the risk associated with it. In this article, we are going to learn about the call put option, call put meaning, call and put options examples, share market call and put, and the difference between call and put option

What Is A Derivative?

A derivative is a financial instrument. The basic definition of a derivative is that its value is derived from some other thing.  For example, suppose Cristiano Ronaldo has signed a T-shirt. The original price of the T-shirt is Rs. 1000, but the minute Christiano Ronaldo signed on that T-shirt the value increased tremendously because of high demand. Hence, the value of the T-shirt is now derived from Christiano Ronaldo's success and the value of the T-shirt will fluctuate based on the performance of Cristiano Ronaldo. 

Key Takeaways

• A buy-put option allows traders to earn profits when the market is down.
• Whenever you trade in Futures & Options, it comes in lot sizes. So, you cannot buy one share. The lot size is pre-decided by the stock exchange. 
• Future & Options gives you leverage which means you get to trade with borrowed money. This is the reason it is extremely risky. 

Types of Derivatives

There are 4 types of derivatives in the share market: Forward, Futures, Options, and Swaps. Among these four derivatives, forwards and swaps are not traded in the stock market. 

Forward: Forward means that you are taking a bet today on the future or forward. Let's understand with an example, a farmer is cultivating onions and he is assuming that the price of the onions will decrease after 3 months. Let's say, the price of onions per Kg is Rs. 20 today and after 3 months it may reach Rs. 15. So, the farmer buys a forward contract from a trader, which means even if the price of the onion falls down the trader is obliged to buy the onions from the farmer at a predetermined price. However, there is no authority to ensure the contract in Forward contracts. 

Futures: Futures contract is listed in the stock market and the exchange itself authorizes it. So, the exchange takes the responsibility that if you take any futures contract then you will get the stock and the one who is selling is also ensured by the exchange. Futures contracts are of 3 types: This month, next month, and far month. But one thing you need to know about the Future option is that at the deadline, you will have to buy the stocks that day only. In other words, you have to take the delivery of the stocks. However, a Futures contract is tradable which means you can trade it like a stock. For example, you buy a futures contract of a Reliance stock and you can sell it whenever you want to. So, you can sell the contract, the minute you get a little profit. Make sure that you have sufficient amounts in your Demat account to take the delivery. 

Options: Options give you the option of buying and selling on the day of delivery. On the date of delivery, you will have the option to buy or not to buy at that price. For example, Reliance stock is trading at Rs. 2100 right now. You assume that the price will increase to Rs. 2200 after a month. So, you decided that you will buy Reliance shares at Rs. 2150 after one month. Let's say, the stock price has reached Rs. 2500 after a month. In options, you get a 10% margin, which means you will have to give Rs. 200 per share. The margin paid is Rs. 200 at a stock price of Rs. 2100. so the total cost incurred is Rs. 2350. Hence, you are getting a stock worth Rs. 2500 at Rs. 2350. But at the other end, let's say the stock price has reached Rs. 2000 from Rs. 2100. Now that you have given a margin of Rs. 200, you can buy this stock at Rs. 2150, or have the option of not buying it. If you buy the stock, you will be at loss. 

Options are categorized into two types: 

Call Option

A call option is an option to buy a share at a specific price at a future date. It allows the trader to buy the shares at a certain price in the future. If traders speculate that the price of the security will rise, they can sell a put option. When a trader opts for a call option, they buy the shares at the strike price and hope that the price of the stock will rise. And if the stock price rises, the trader can buy at the strike price which means they buy the shares at a lower price and can sell them to earn a profit.

Put Option

A put option is an option to sell a share at a specific price at a future date. If traders speculate that the price of the security will fall, they can buy a call option. When a trader opts for a put option, they get the right to sell shares at the strike price and hope that the stock price will decrease. if the stock price reaches lower than the strike price, they can sell the shares to earn profit. 

Call and Put Options Examples

Example of a call option: 

Let's say, you bought a share of a company ABC for Rs. 2100 and the option's value is 10%. You bought shares worth Rs. 2100 by giving Rs. 200. Let's assume the lot size is 100. So, you gave 200*100 = Rs. 20,000 and got shares worth Rs. 2,10,000. If the share price increases to Rs. 2300 from Rs. 2100, which means the share price increases by Rs. 200. So, the total profit is the profit per share (200)* lot size (100) = Rs. 20,000. Hence, the total profit is Rs. 20,000 on the investment amount of Rs. 20,000. 

But if the trade goes wrong or the other way, for example, if the stock price will decrease by Rs. 200. The stock value of Rs. 2100 will reach Rs. 1900 in the future. Your loss per share will be Rs. 200 and your total loss amount will be [loss per share (200)* lot size (100)] = Rs. 20,000. 

Difference Between Call and Put Option

1. Call options give you the right to buy shares. Whereas put options give you the right to sell shares. 
2. In the case of call options, there is unlimited risk associated with the option seller. On the other hand, in the case of put options, there is limited risk associated with option sellers. 
3. In the case of a call option, there is limited risk for option buyers. Whereas in the case of a put option, there is limited risk for the option buyer. 

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To conclude, trading in Futures & Options provides a lucrative avenue to many traders. Traders speculate on the price of the security and get attractive returns when the trade goes well. It is suitable for those who have a high-risk appetite and have a good understanding of futures & options.