If you deal in Futures and Options, you should know about the call and put option. While trading in options, investors need to use these contracts. However, to use them, you must first learn the difference between call option and put option.
In this article, we do a call option vs put option comparison. So, let us begin with definitions of call vs put.
What is the difference between call option and put option?
While dealing in the options derivative category, the right to buy the underlying stocks at a pre-decided price within the contract’s validity is the call option. The right to sell is the put option.
How do call and put options work?
In order to buy or sell in the options market, you have to either place a call option or a put option. When you purchase a call option, you have to pay an upfront premium, which is a portion of your total cost of purchase. The brokerage requires this amount to hedge against risks.
Because there is no compulsion to actually buy the stocks, this may lead to a loss for the brokerage. So, there is no compulsion to execute the buying even after you have paid the upfront amount.
However, when you purchase a put option, you are obligated to execute the trade if the call buyer has done his part. If the call buyer with whom you have made the contract has not done his part, you don’t have to either.
There is an upfront payment with put options as well.
Similarities between call and put option
Time is a factor in both these options. If the contract is not consummated within its given time frame – be it the selling or the buying – the contract is not valid.
Both parties have to pay an upfront premium to participate in the options market.
The maximum loss they can both incur is the premium they have paid.
Differences between call option and put option
While call and put options perform different tasks, they both make an options’ contract valid. They are both crucial for execution.
However, to understand the matters better, let us draw a comparison table of call vs put.
|Call option enables you to buy a stock within a fixed time frame at a strike price
|Put option enables you to sell a stock within a fixed time frame at a strike price
|No. Call buyers can drop out of the contract and not execute the purchase if the share falls and there would be losses.
|Yes. If the call option buyer has done their part, you have to execute your trade.
|Buyer of this option
|Buys the stock
|Sells the stock
|If the stock market climbs
|There is a profit
|There is a loss
|What’s the maximum they can gain
|Unlimited because it can’t be predicted earlier how much the equity would rise
|Limited by the scope of their selling cost
|Profits come when the share price
Understanding the difference between call option and put option with examples
Let us say Rajesh purchased a put option for selling 20 shares of a company at INR 5,000 each after two months. Mukund has entered the contract with a call option of buying the shares at the same price, volume, and time frame.
However, if the price increases to INR 7,000, Rajesh would make a loss. However, he would still have to sell the shares for much less than their market worth. This is when purchasing a call option helps. If the price of a share appreciates, your investment works.
Now, let us look at how it works if the price of the share falls to INR 4,500. Now, purchasing the share at INR 5,000 would make it a bad trade for Mukund. So, being a call buyer, he can choose to walk out. He doesn’t have to buy the stocks underlying the contract. When he walks out, he is not charged a penalty, but his loss is the premium he paid.
If he chooses to buy the shares nonetheless, it’s a profit for the put option buyer. He can sell the shares at a higher price and use the difference for his next investment, profits, liquidity, etc.
For your call option to be profitable, the shares you purchased the contract for have to appreciate in the given time frame, so that you can trade them in the market openly and make profits.
For your put option to have gains, the shares you have to sell must depreciate in price, so that if the buyer goes through with his trade, you have to sell the shares at higher prices than what is currently prevailing in the market. You can then use the remainder to buy the shares back for a lesser sum.
Call option and put option are both parts of the same cycle of options contracts. The person who buys the call option has to buy and the person who buys the put option has to sell the shares, respectively. The price is pre-decided and based on the market’s fluctuations, the profits are made.