Call Option and Put Option – Meaning, Features, Examples and Difference

Call Option Meaning

Call option give the buyer a right but not the obligation to buy the underlying asset at the strike price within the stipulated time period. The call option is taken only when investor thinks that price of underlying asset will rise in future. For buying a call option we have to pay only the premium money not the price of the underlying asset. Call option is profitable only when underlying asset trade over the strike price. Call option contract are always made in lot size. We cannot make a call option contract for a single share.

Call Option Features

1. Call option give the buyer a right but not the obligation to buy the underlying asset at the strike price within the stipulated time period.

2. Value of call option increases with the increase in price of underlying asset.

3. It gives the buyer right to buy the underlying asset.

4. It has a direct relationship with market or underlying asset.

5. Potential gain is unlimited in case of call option.

6. Premium paid for buying call option is basically a security deposit for buying the underlying asset at the strike price.

Example of call option

Mr. A is a regular investor in stock market. He belief that the price of Tata Power will rise in future. So he buy a call option and enters into a contract with B (seller) that he will purchase 5000 shares of Tata Power at Rs. 200 per share after one month. For this purpose he pays a premium of Rs. 5000 to the seller. If after one month the prices of the shares are above Rs. 200 say Rs. 220 than A can purchase shares from B at Rs. 200 by exercising his right and sale them for Rs. 220 in open market and made a profit of Rs. 20 per share.

Total profit of A in such case will be = (220 – 200)*5000 – 5000 = 95000

But if the prices go down below Rs. 200 say 180 then A will not purchase the same from B because he can purchase the same from open market at Rs. 180. In such a situation he will lose only his premium money.

From the above example, we can say that option buying and selling is very profitable but involves huge risk. Investor can lose all his premium money if his prediction goes wrong..

Put Option Meaning

A put option is the opposite of the call option. Put option gives the buyer a right but not the obligation to sale the underlying asset at the strike price within the stipulated time period. The put option is taken only when investor thinks that the price of underlying asset will fall in future. For buying a put option we have to pay only the premium money not the price of the underlying asset.

Put Option Features

1. Put option gives the buyer a right but not the obligation to sale the underlying asset at the strike price within the stipulated time period.

2. Value of put option decreases with the increase in price of underlying asset.

3. It gives the buyer right to sale the underlying asset.

4. It has inverse relationship with market or underlying asset.

5. Potential gain is limited in case of put option.

6. Premium paid for buying call option can be assumed as insurance to cover the loss arises due to fall in prices of underlying asset.

Example of put option

Mr. A is a regular investor in stock market. He belief that the price of Tata Power will fall in future. So he buy a put option and enters into a contract with B (seller) that he will sale 5000 shares of Tata Power at Rs. 200 per share after one month. For this purpose he pays a premium of Rs. 5000 to the seller. If after one month the prices of the shares are below Rs. 200 say Rs. 180 than A can exercise hi right to sale and can make a profit of Rs. 20 per share.

Total profit of A in such case will be = (200 – 180)*5000 – 5000 = 95000

But if the prices go above Rs. 200 say Rs. 220 then A will not will not exercise his right. In such a situation he will lose only his premium money.

From the above example, we can say that option buying and selling is very profitable but involves huge risk. Investor can lose all his premium money if his prediction goes wrong.

Difference between Call option and Put Option

Basis Call Option Put Option
1. Meaning Call option give the buyer a right but not the obligation to buy the underlying asset at the strike price within the stipulated time period. Put option gives the buyer a right but not the obligation to sale the underlying asset at the strike price within the stipulated time period.
2. Value Value of call option increases with the increase in price of underlying asset. Value of put option decreases with the increase in price of underlying asset.
3. Right It gives the buyer right to buy the underlying asset. It gives the buyer right to sale the underlying asset.
4. Relationship It has a direct relationship with market or underlying asset. It has inverse relationship with market or underlying asset.
5. Potential Gain Potential gain is unlimited in case of call option. Potential gain is limited in case of put option.
6. Analogy Premium paid for buying call option is basically a security deposit for buying the underlying asset at the strike price.

Premium paid for buying call option can be assumed as insurance to cover the loss arises due to fall in prices of underlying asset.

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