What is the difference between call and put options?

Options are a popular tool in financial markets, especially in trading. They give investors the right, but not the obligation, to buy or sell an underlying asset, like a stock, at a specific price before a certain date. There are two main types of options: call options and put options. Let's take a simple look at both.

What is a Call Option?

A call option gives the buyer the right to buy the underlying asset at a specific price (called the strike price) within a certain period. Traders usually buy call options when they believe the price of the asset will go up. If the price goes up, they can buy the asset at the strike price, which is lower than the current market price, and potentially make a profit.

Example of a Call Option

Suppose you buy a call option for a stock with a strike price of ₹100, and the stock is currently trading at ₹90. If the price rises to ₹120, you can exercise the option to buy the stock at ₹100, even though it's worth ₹120 in the market. You can then sell the stock for ₹120, making a profit of ₹20 per share (minus the cost of the option).

What is a Put Option?

A put option, on the other hand, gives the buyer the right to sell the underlying asset at a specific strike price within a certain period. Traders usually buy put options when they believe the price of the asset will fall. If the price falls, they can sell the asset at the higher strike price, which is more than the current market price, and potentially make a profit.

Example of a Put Option

For example, you buy a put option for a stock with a strike price of ₹100. If the stock falls to ₹80, you can exercise the option to sell the stock for ₹100, even though it's only worth ₹80 in the market. You can sell the stock at ₹100 and make a profit of ₹20 per share (minus the cost of the option).

Key Differences Between Call and Put Options

• Call Option: Gives the buyer the right to buy the underlying asset at the strike price.
• Put Option: Gives the buyer the right to sell the underlying asset at the strike price.
• Profit from Rising Prices: Traders buy call options when they expect the asset price to rise.
• Profit from Falling Prices: Traders buy put options when they expect the asset price to fall.
• Risk of Loss: The maximum loss for both options is limited to the price paid for the option.

Advantages of Call and Put Options

Both call and put options offer flexibility to traders. They provide opportunities to profit from both rising and falling markets. Additionally, options can be used as a hedging tool to protect other investments in your portfolio. The risk is limited to the premium paid for the option, making them a low-risk strategy compared to buying the underlying asset directly.

Disadvantages of Call and Put Options

While options offer a lot of potential, they also come with certain risks. If the market does not move in the direction you expect, you could lose the entire premium paid for the option. Additionally, options have an expiration date, meaning if the asset price does not reach the strike price by the time the option expires, the option becomes worthless.

Conclusion

Call and put options are powerful financial tools that offer traders the opportunity to profit from market movements without actually owning the underlying asset. While they are beneficial for speculation and hedging, it’s important to understand the risks involved before using them. Whether you're bullish (expecting the price to rise) or bearish (expecting the price to fall), options can help you navigate the market with more flexibility.