Today Derivatives or Futures and Option tyrading has becoming most popular between the youths especially.
While many wanted to become a part in this euphoria to make some quick money but unable to understand what is CE and PE in Stock Market, key difference between Call Option and Put Option, how do they work, their pros and cons, etc.
Thus, I have prepared an extensive for you to answer all your queries in a most simple and logical way.
So let’s Get Started!
Table of Contents
What is Call Options (CE) in Stock Market
Call Option or CE is a type of Option that gives you right to buy a particular asset (in case of stock market it can be stock) at a particular price in the specified time.
While you should note option itself means you have a choice and not obligated to buy that stock.
You can purchase a call options of any stock (that are available for FnO Trading) if you think that the stock price will shoot up in a certain time.
Or you can also sell a call option if you think that the stock price will go down in a certain time.
Do remember there is an expiry date of a call option and as the expiry date approaches the value of call option decreases.
What is Put Options (PE) in Stock Market
Put Option or PE is opposite of call option that gives you right to sell a particular asset (in case of stock market it can be stock) at a particular price in the specified time.
Again it’s your choice and not a obligation to sell that stock.
Unlike call option put option works just opposite, if you think that the price of a particular stock price will go down up in a certain time then you can purchase a put option if that is available for Future and Options trading.
Or you can also sell a put option if you think that the stock price will shoot up in a certain time.
Similar to call option (CE) put option (PE) also have an expiry date.
Do note both Call Option (CE) and Put Option (PE) are derivatives and hence, they don’t have their own value just like a stock of a company has, they derive the value from the underlying asset.
Option Buyers vs Option Sellers
Option Buyers
- Call Option Buyers: These investors purchase call options when they anticipate that the price of the underlying asset will increase. By paying a premium of call option, they acquire the right to buy the asset at the strike price. If the asset’s price rises significantly, they can either exercise the call option or sell it at a profit.
- Put Option Buyers: Investors buy put options when they expect the price of the underlying asset to fall. They pay a premium for the right to sell the asset at the strike price. If the price drops below this strike price, the put option becomes more valuable.
**Do note that an option buyer pay a premium for buy the option, and that is the maximum loss they can incur if the market does not move in their favour.
But if it moves in their favour they have a chance to make unlimited profit.
Option Sellers (Writers)
- Call Option Sellers: Also known as “writers,” these investors sell call options and receive the premium upfront. They are betting that the price of the underlying asset will not exceed the strike price by expiration. If the asset’s price remains below the strike price, the call option expires worthless, and the seller keeps the premium.
- Put Option Sellers: Similar to call sellers, put option sellers receive a premium when they sell put options. They are betting that the price of the underlying asset will not fall below the strike price. But if put option exercised, they may have to buy the asset at the strike price, potentially incurring losses.
**Do note that an option seller or option writers have to maintain a margin in their trading account, which serves as collateral to cover potential losses.
For an option seller the maximum profit they can earn is equivalent to the premium they have already received while the maximum loss they can face has no limit.
Call and Put Options Examples
To better understand the key difference between call option and put option let’s just take an example of State Bank of India Options.
As you can see currently SBI stock is trading at Rs. 792.
Case 1: Buying Call Option
Now if you think the price of SBI stock will increase and can easily cross Rs. 800 in next few days from this point then you can purchase a call option.
CE means Call Option
As you can check the premium of SBI September call option is Rs. 1.95, you can purchase it but you have to sell it before it’s expiry.
Case 2: Selling Call Option
There is second case too, where if you believe that either the SBI stock will not be able to cross Rs. 800 price till the last Thursday of September month (expiry date of this call option contract) or will remain equal to Rs. 800.
Then you can sell a call option, for which you have to maintain a margin so that if your option go in loss so it can be covered through the margin.
Case 3: Buying Put Option
If you believe, that SBI stock will fall further from Rs. 792 then you can buy a Put Option of September expiry and Rs. 800 strike price.
PE means Put Option.
As you can check the current premium of this put option is Rs. 9. Thus, if you want this put option for right to sell later, you can pay this Rs. 9 premium and can buy this put option.
Unlike selling the call option where your loss is unlimited and profit is limited here the situation is completely opposite where your profit opportunity on stock decline is unlimited while the loss is limited to the premium you have paid.
Case 4: Selling Put Option
In this fourth case, let’s say you are bullish on SBI stock but not 100% confirm whether it can cross Rs. 800 till September Last Thursday (expiry date of this option contract).
Then you can sell a put option where you will get the premium upfront and at least if SBI even don’t cross Rs. 800 then still you can keep the premium you have already gotten in the form of your additional earning.
But again for selling a put option too you have to maintain a margin in your demat account.
Call Option vs Put Option
Understanding the differences between call and put options is vital for making informed trading decisions. Here’s a concise comparison:
| Feature | Call Option (CE) | Put Option (PE) |
|---|---|---|
| Meaning | Right to buy an underlying asset in future | Right to sell an underlying asset in future |
| Price Indication | Used when we are bullish (expecting price increase) | Used when we are bearish (expecting price decrease) |
| Profit Potential | Unlimited above the strike price | Limited to the strike price minus market price |
| Risk Level | High risk due to time decay | High risk, especially with rapid declines |
Margin Calculation for Selling Call and Put Options
Call Options
- Cash-Secured Call Writing:
- If you are selling a covered call option means you already own the stock of which you are writing a call option then the margin requirement is typically lower.
- Margin = Number of Shares x Current Price of the Stock.
- Naked Call Writing:
- If you sell a naked call option means without owning the underlying stock then the margin requirement is usually higher.
- The margin is calculated using:
- Initial Margin = 100% of the option premium received + 20% of the underlying stock price – out-of-the-money amount (if any).
- This can vary by broker, so it’s essential to check their specific calculations.
Put Options
- Cash-Secured Put Writing:
- If you have the enough cash to buy the stock at lower value or exercise the put option if the put option doesn’t go as per your thinking then it is known as cash-secured put writing.
- Margin = Strike Price x Number of Contracts x 100 (since each contract typically represents 100 shares).
- This amount must be in your account as collateral.
- Naked Put Writing:
- While if you’re selling a put option without having enough cash to purchase the stock if put option exercised then it is known as naked put writing, the margin requirement can vary widely.
- A common calculation is:
- Initial Margin = 100% of the option premium received + 20% of the strike price – out-of-the-money amount (if any).
- Again, this can differ based on your broker.
Factors Affecting Call Option and Put Option Prices
There are many factors that affect the prices or premium of both call and put options thus, before trading any option it is very important for you to understand it.
1. Underlying Asset Price
The underlying asset price or underlying stock price affects the premium of call and put options.
Case 1: Stock Price / Underlying Asset Price Increase
Premium for buying the call option will increase and premium for buying the put option will decrease.
Case 2: Stock Price / Underlying Asset Price Decrease
Premium for buying the call option will decrease and premium for buying the put option will increase.
2. Expiry Date
As the date approaches near to expiry date of the particular option it’s value decrease and eventually becomes 0.
Thus, if you are an option buyer you will have to sell your option before it approaches to zero or you will face a loss.
You have three options:-
- Exercise the Option: If you find this as a profitable opportunity you can choose to exercise the option buy buying or selling the underlying asset of that option based on whether you opt for call or put options.
- Sell the Option: You can sell the option in the market before it expires to book the profit if you are in profit or to avoid 100% capital loss you have invested in buying that option.
- Let It Expire: If the option is out of the money and unlikely to be exercised, they may let it expire worthless. If you are an option seller then in this case you will be in profit because you have already received the premium upfront.
Volatility Impact
To know the volatility you should check the India VIX index, higher the India VIX more the volatility and vice versa.
- Increased Volatility: If there’s increased volatility as expiry approaches, the option’s premium may rise, potentially benefiting the option buyers.
- Decreased Volatility: Conversely, if volatility decreases, the premium may fall, making it more favourable for option sellers.
Interest Rates: Rising interest rates generally boost call option prices and diminish put option prices due to the cost of carry.
Market Sentiment: General investor sentiment can sway options prices; bullish sentiment usually favors call options.
Can I also trade bank nifty call put option?
Yes, you can also trade in the bank nifty call put option. Although the bank nifty is an index and it’s call put option premium depends whether bank nifty is increasing or decreasing.
Can I trade in nifty call and put options?
Yes, you can trade in the nifty call and put options. Nifty is an index and it’s call put option premium depends whether the nifty is increasing or decreasing.
Final Words – Call and Put Options
Using the power of derivative trading can be lucrative and can look like a quick rich scheme.
But do remember trading call and put options are highly risky and has the 1-2% success rate only, that means 98-99% people lose the money int the market due to this options trading.
Moreover, it can act as a gambling if you don’t have proper experience and know the actual difference between call option and put option how do they work in real situations.
In a gambling you should always understand one thing that it is not you who will make the most amount of money from your gambling but the one who is allowing you to play that gamble makes the most money which in this case are brokers.
Disclaimer: The Honest American provides financial education, investing strategies, & stock market news for informational purposes only and should not be construed as investment advice. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.
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