Difference Between Call and Put Options: Explained with Meaning & Examples

Key Takeaways

• Call options provide the right to buy an asset. Traders buy call options when they anticipate a rise in the asset price.
  

• Put options offer the right to sell an asset. Traders buy them when they anticipate a decline in asset price.
  

• Call options are suitable for the bullish markets. However, put options are preferred in bearish markets.
  

• Profits from call options may be unlimited. However, you will get limited profits with put options.
  

• When call options are in-the-money, the strike price is lower than the spot price. However, the strike price is higher than its spot price when the call option is out-of-money. This is the opposite for the put options.
  

Options are impactful financial instruments that provide traders like you with the flexibility to profit from market movements, be it when prices are rising, falling or even staying flat. Unlike traditional stock investing, options offer strategic ways to manage risk, hedge portfolios or amplify potential returns. At the heart of options trading lie two core instruments: call options and put options. This article takes a closer look at what they are, how they work, and how they fit in a diversified investment portfolio.

What Is a Call Option?

With a call option, you get the right (but no obligation) to purchase a stock at a pre-specific price (strike price), before a specified expiration date. Traders usually buy call options when they expect the price of the underlying asset to increase. When the asset price goes above the strike, the holder can buy the asset at a low price. Thus, they get the asset at a lower price than the existing market price.

How to Calculate Call Option Payoffs?

Knowing how to calculate call option payoffs is essential if you are looking to navigate the options market with confidence. As mentioned earlier, a call option gives the buyer the right, but not the obligation, to purchase an underlying asset at a predetermined price before or on the expiry date. The payoff from a call option depends on the difference between the market price of the asset at expiry and the strike price, minus the premium paid. If the asset’s price rises above the strike price, the option becomes profitable; if it stays below, the maximum loss is limited to the premium. Accurately calculating this payoff helps you as a trader assess potential returns, manage risk and make informed decisions in volatile markets.

What Is a Put Option?

With a put option you have the right, without any obligation, to sell a particular asset, frequently a stock, at a predetermined strike price before a specified expiration date. Essentially, put options provide investors like you with a strategic advantage, enabling them to profit from a potential decline in the stock's market price. When the market price goes below the strike price, the holder can sell the asset at the higher strike price, thus reaping a gain.

How to Calculate Put Option Payoffs?

Calculating the payoff of a put option is an important step in understanding how this powerful derivative can work for you. A put option, as previously mentioned, gives the buyer the right, but not the obligation, to sell an underlying asset at a specified strike price before or on the option’s expiry. The payoff from a put option is determined by how far the market price falls below the strike price, which means the greater the drop, the higher the profit. If the asset’s market price stays above the strike price, the put expires worthless, and the loss is limited to the premium paid. By knowing how to calculate the payoff, as a trader, you can effectively evaluate downside protection strategies or profit from anticipated price declines.

Difference Between Call and Put Option

Here are the differences between call and put options on various aspects:

Important Terms Related to Call and Put Options

• Strike Price or Exercise Price: The fixed price at which the underlying asset can be bought (call) or sold (put) if the option is exercised.
  

• Premium: The price paid by the buyer to the seller (writer) for the option contract. It’s non-refundable and represents the cost of the option.
  

• Expiry Date: The last date on which the option can be exercised. After this, the option becomes void.
  

• At the Money (ATM): When the current market price is equal or nearly equal to the strike price.
  

• Intrinsic Value: The real value of an option if exercised now: Call: Market Price – Strike Price
  Put: Strike Price – Market Price
  

• Time Value: The portion of the option premium that exceeds the intrinsic value, reflecting the time left to expiry.
  

What Happens to Call Options on Expiry?

In-the-Money (ITM) Call Options If a call option expires in the money, it is generally exercised automatically by the exchange. The holder receives the intrinsic value minus any applicable charges.

Out-of-the-Money (OTM) and At-the-Money Call Options If a call option expires out of the money or at the money, it expires worthless. The holder, thus, loses the premium paid for the option, but there are no further obligations or losses beyond this amount. The contract just lapses from the account after expiry.

What Happens to Put Options on Expiry?

Physical Settlement for Stock Options If a stock put option expires in the money, it is subject to physical settlement. Thus, the option holder must deliver (sell) the underlying shares at the strike price to the option writer, or if they don’t own the shares, they must acquire them to settle the contract.

If the put option is out of the money or at the money, it expires worthless, and no action is required. The premium paid is lost and no further obligation exists.

Cash Settlement for Index Options For index put options, expiry is settled in cash. If the put expires in the money, the profit is paid as the difference between the strike price and the index’s closing price on expiry day, minus the premium paid.

If the index put is out of the money or at the money, it expires worthless, and the premium is lost.

Conclusion

Call option and put option hold a place of significance in investors’ toolkit, allowing for a nuanced approach to market dynamics. Mastering these essential derivatives equips individuals like you with the flexibility to adapt to changing circumstances, ensuring they can navigate the financial landscape with confidence and agility.

Read more: Intraday Trading Guide for Beginners