Call and put options are financial contracts that derive value from an underlying asset, such as a stock, bond, or commodity. These contracts grant the holder the right—but not the obligation—to buy or sell an asset at an agreed-upon price or strike price on or before a specified expiration date.

Among the most commonly discussed financial derivatives are call and put options, each playing a distinct role in investment strategies. This article explains what call and put options are, how they work, and their practical applications.

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Call Options Explained

When investors purchase a call option, they anticipate the asset’s price will rise higher than the strike price before the option expires. 

If the asset's market price is higher than the agreed price, the call option is deemed "in the money," enabling the holder to exercise it and acquire the asset at a favorable price. However, if the market price remains below the strike price, the call option expires without value.

Example of a Call Option:

Suppose you purchase a call option for a business’ stock with a strike price of $50, paying a premium (the cost of purchasing the option contract) of $5 per share. If the stock’s market price rises to $55 or $60, you can exercise the option and buy the stock at $50, securing a $5 or $10 per share profit (minus the $5 premium).

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Put Options Explained

A put is just the opposite of a call. When you buy a put option, you are speculating that the underlying asset's price will fall below the strike price.

If the market price drops below the strike price, the put option is “in the money.” This allows the holder to sell the asset at a higher price. If the market price rises above the strike price, the put option expires worthless.

Example of a Put Option:

Imagine you buy a put option for EFG Corp’s stock with a strike price of $40, paying a $3 premium. If the stock’s price falls to $30, You can sell it at $40, making a $7 per share profit ($40 - $30 - $3 premium = $7).

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Call And Put Options Real-World Examples

Let’s explore real-world scenarios to see how call and put options work:

Example 1: Using A Call Option For Speculation

An investor anticipates that TechCo’s stock, currently priced at $100, will experience a significant increase. They purchase a call option with a $105 strike price, set to expire in three months, at a premium cost of $4. If TechCo’s stock price rises to $120, the investor has the right to buy the stock at $105, resulting in a profit of $15 per share ($120 - $105 - $4 premium).

Example 2: Using A Put Option For Hedging

A portfolio manager owns 1,000 shares of RetailInc, currently trading at $50 per share. Concerned about potential market volatility, they buy put options at a $48 strike price, paying a $2 premium per share. If the stock falls to $40, they can sell their shares at $48, minimizing losses.

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Writing Call And Put Options

Writing call and put options refers to creating and selling buyer options contracts. When an investor writes (sells) an option, they take on the obligation of the option in exchange for the premium the buyer pays. Here’s how it works:

Writing A Call Option

When you write a call option, you agree to sell the asset to the buyer at the agreed price or strike price if the option is exercised. This is known as a covered call if you own the underlying asset, or a naked call if you don’t own it (a risky strategy due to unlimited loss potential).

Example:

• You write a call for 100 shares of Stock QRS with a strike price of $30, collecting a premium of $2 per share.
• The buyer may exercise the option if the price rises above $30. This means you must sell the shares at $30, even if the market price is higher.
• If the stock remains under $30, the option will expire without value, allowing you to retain the $2 premium as your profit.

Writing A Put OptionWhen you write a put option, you agree to buy the asset from the buyer at the agreed-upon price if the option is exercised. This can be used as a strategy to acquire an asset at a desired price or generate income.

‍Example:

• You write a put for 100 shares of Stock EFG with a strike price of $40, collecting a premium of $1 per share.
• If the stock price falls below $40, and the buyer decides to sell the option, you must purchase the shares at $40, even if the market price is lower.
• If the stock stays above $40, the option expires worthless, and you keep the $1 premium as profit.

Risks And Benefits Of Writing Options

• Premium Income: Writers earn the premium upfront, which can be a consistent income source.
• Obligation: The writer must fulfill the contract’s terms if the buyer exercises the option.
• Potential Losses: Writing naked options (without owning the asset or necessary cash) can lead to significant or unlimited losses.

Writing options can be a powerful strategy when done with proper risk management and understanding, but it carries risks that demand careful planning.

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Call Options Vs Put Options: Summary

To compare call options vs put options, it’s essential to focus on their purposes and use cases:

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Conclusion About Call And Put Options

Options trading, particularly with call and put options, offers a powerful way to diversify investment strategies, manage risk, and speculate on market movements. 

By understanding how call options vs put options function, investors can tailor their approaches to align with their financial goals and market outlook.

Ready to take your options trading knowledge to the next level? Join the FREE Options Trading Masterclass by Next Level Academy. Contact us today!

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Frequently Asked Questions About Call And Put Options

How Do Call And Put Options Differ?

Call options are used to profit from price increases, while put options are used to benefit from price declines.

Is It Risky To Buy Call Or Put Options?

Yes, options carry inherent risks, including the potential loss of the premium paid. It’s essential to learn the mechanics and risks before trading.

Can Beginners Trade Options?

While options can be complex, beginners can start with basic strategies like buying calls or puts. Education and practice are crucial.

How Is Options Trading Used?

Options can be used for hedging, speculation, and income generation, depending on the trader’s objectives and market views.