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Call Option | Put Option - Option Trading Basics

HomeCall Option | Put Option – Option Trading Basics

Recommended before reading this section:

Derivative Trading in India – Forward and Future Contracts


An option gives the buyer (holder) a right but not an obligation to buy or sell an asset in future. Options are of two types – calls and puts.

Basic Call Option 

A call option is an option contract which gives the buyer of the call option a right (but not the obligation) to purchase a certain quantity of securities like stock, bond or other financial instruments at a pre-determined price on or before a pre-determined date from the option seller. The buyer of the call option has the right to exercise the option or not. The buyer pays an option premium to acquire such a right.

Put simply, the buyer pays a premium to get a right to buy the underlying security at an agreed price in future. If the market price of the underlying security rises above this agreed price (i.e. the strike price1), the buyer of the option will exercise his right (i.e. he will buy the underlying security at the strike price and can immediately sell the security at the market price). The buyer of the call option is called the option holder and the seller of the option is called option writer.  

As long as the price of the underlying asset (S) remains below the strike price (X), the buyer of the call option will not exercise it; and the loss of the buyer would be limited to the premium paid on the call option.

When S < X

Buyer lets the call expire

Loss = premium

When S = X

Buyer lets the call expire

Loss = premium

When S > X

Buyer exercises the call

Gain = S – X – premium

In The Money Call Option and Out of the Money Call Option

A call option is in the money when the market price of the underlying stock is greater than the exercise price of the option; a call option is out of the money when the market price of the underlying stock is less than the exercise price of the option.

For example:

Suppose an investor purchases a call option to buy a share of Company A which is currently trading at Rs. 180. The strike price of the option is fixed at Rs. 190. The expiry date is set at one month from the purchase date. The buyer may exercise the option at any time on or before the expiry date. The buyer pays a premium of Rs. 2 per share to purchase the option.

Now if within one month the market price of the stock goes above Rs. 190, lets say, Rs. 200. By exercising the option he stands to gain immediately Rs. 8 (Rs. 10 – Rs. 2) as he gets one share by paying Rs. 190 and sells immediately in the market at Rs. 200.

If the market price does not go above Rs. 190 before expiry, the option holder will not exercise the option. He loses the option premium paid to the option writer.

Note: It is important to note that the option buyer pays the option premium at the time of purchasing the option. This is the maximum loss which he could suffer. In other words, he only stands to gain if the price of the underlying rises above the strike price and can suffer no more loss than the option premium paid. On the other hand, in future contracts, the buyer could suffer very large losses as his margin account is marked to market at the end of each trading session. 

Mark to Market – In the future market, at the end of each trading day, the future closing price is marked to the market price of the underlying security and the trader’s margin account is adjusted to reflect the his gain or loss. This results in daily gain or loss for a future trader.


 Basic Put Option

put option is an option contract which gives the buyer of the put option a right (but not the obligation) to sell a certain quantity of securities like stock, bond or other financial instruments at a pre-determined price on or before a pre-determined date to the option seller. The buyer of the put option has the right to exercise the option or not. The seller of the put option however has an obligation to buy the underlying security whenever the buyer exercises the option.

Put simply, the buyer pays a premium to get a right to sell the underlying security at an agreed price in future. If the market price of the underlying security falls below this agreed price (i.e. the strike price1), the buyer of the option will exercise his right (i.e. he will sell the underlying security at the strike price and can immediately buy the security at the market price). The buyer of the put option is called the option holder and the seller of the option is called option writer.  

As long as the price of the underlying asset (S) remains above the strike price (X), the buyer of the put option will not exercise it; and the loss of the buyer would be limited to the premium paid on the put option.

When S < X

Buyer exercises the option

Gain = X – S – premium

When S = X

Buyer lets the contract expire

Loss = premium

When S > X

Buyer lets the contract expire

Loss = premium

In The Money Put Option and Out of the Money Put Option

A put option is in the money when the strike price is higher than the market price of the underlying security. A put option is out of the money when the price of the underlying security is greater than the strike price. 

For example:

Suppose an investor purchases a put option to sell a stock of Company A which is currently trading at Rs. 180. The strike price of the option is fixed at Rs. 175. The expiration date is set at one month from the purchase date. The buyer may exercise the option at any time on or before the expiration date. The buyer pays a premium of Rs. 2 per stock to purchase the option.

Now, if within one month the market price of the stock goes below Rs. 175, let say, Rs. 160. The option holder will exercise his option and sell the underlying stock to the option writer at a price above market price. By exercising the option he stands to gain immediately Rs. 13 (Rs. 15 – Rs. 2) by selling the share for Rs. 175 and using the proceeds to buy the share from the market at Rs. 160.

If the market price remains above Rs. 175 until expiry, the option holder will not exercises the option and will suffer a loss to the extent of the option premium paid. 

Recommended for you:

 – Option Trading Strategies


1The strike price is defined as the price at which the holder of an option can buy (in the case of a call option) or sell (in the case of a put option) the underlying security when the option is exercised. Hence, strike price is also known as exercise price.

About the Author

Rajat Sharma pictureRajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.