Difference between Call and Put Option | Explained With Example

Difference between Call and Put Option

The option contract is the contract between two parties which provide the rights not obligation to buy or sell the underlying securities/ assets on or before a future specified date at a predetermined price. Moreover, the options contract can be of two types: Call Option and Put Option.

In this article, we will discuss what are the call and Put Option and the difference between call and put option.

Call Option and Put Option:

“The call options refer to the contract/ agreement between buyer and seller which provide rights (not a compulsion) to buy the underlying securities at an agreed (predetermined) price on or before the expiry date of the contract.”

On the other hand, “Put Option refers to the contract between buyer and seller which provide rights not obligation to sell the underlying securities at a predetermined price on or before the expiry of the contract.”

In short, we can say that call options are those options contracts which provide rights to option holders to buy the financial assets within a stipulated time period, conversely, if it allows to sell specific lots of financial assets during a certain period of time, it will be known as Put Option.

One important note regarding the call and put options is that neither call option nor put option imposes a compulsion/ obligation to buy or sell the underlying assets. The option holders can also forfeit the contract if the conditions are not favourable to them.

Call Option vs Put Option (Comparison Table):

ASPECTS OF COMPARISONCALL OPTIONSPUT OPTIONS
MeaningIt is a contract/ agreement between buyer and seller which provide rights (not a compulsion) to buy the underlying securities at an agreed (predetermined) price on or before the expiry date of the contract.It is a contract/ agreement between buyer and seller which provide rights (not a compulsion) to sell the underlying securities at an agreed (predetermined) price on or before the expiry date of the contract.
Rights ProvidedBuy SecuritiesSell Securities
Speculators ExpectationsRise in priceDecline in Price
Speculators GainsWhen price increasesWhen price decreases
Profits/ GainsCould be unlimitedLimited
Investors' PerspectiveWhenever planning to buy new stocks in future.To secure the value of existing stocks.
Real life examplesDeposit of token (booking amount) money to buy something (car) at pre-fixed price.Car Insurance providing protection against a loss in value due to damage/theft etc.

Difference between Call and Put Option:

Now let’s discuss how the call and put options are different from each other.

  • As the definition suggests, the main difference between call and put option is, the call option allows the option holders to buy a certain lot of underlying assets before the expiry date of the contract, however, put option allows the option holders to sell the underlying assets (specific lot) before the expiration of the contract. But none of them obligates to buy or sell the securities, it is the option holders’ interest whether to exercise the options contract or not.
  • Call options holders gain profit when the market price of underlying assets appreciates, on the other hand, Put option holders make money if the price of underlying securities declines in the market.
  • The spectaculars who expect a significant rise in the market in future buy the call options, on the other hand, those who expect the market is going to decline in future typically go for put options.
  • Hence, people who hold the call option always expect the market price of underlying securities may increase, however, the persons who hold put option expect to decrease the price of underlying securities in the open market.
  • The call option is always exercised whenever the price of underlying assets is more than the strike price, on the other hand, put option are exercised if the security price is less than the strike price.
  • The probability of potential gain in call options could be unlimited as the price of securities might increase higher logically and mathematically whereas the in case of a put option, the potential gain could be up to a certain extent (Limited) because the market price of any security cannot be zero.
  • A premium is mandatory to buy a call option but margin money isn’t required to deposit in the stock exchange, on the other hand, margin money is compulsory to buy a put option.

Call and Put Option Example:

Let us first consider the shares of TCS Ltd as underlying security whose current market price is Rs 500/- per share (say) and Mr X and Mr Y are two investors/ spectator having two different perceptions regarding the price movement of share.

  1. According to Mr X perception, the share price of TCS is going to increase in the next 3 months, contrary Mr Y expects that share of TCS would decline after three months.
  2. Now to make potential gain Mr X buys the call option (Lot of 1000 shares) of TCS Ltd as he is expecting that the shares of TCS would rise after 3 months, however, Mr Y buys put option (One lot of 1000 shares) so that he can make a profit when the shares of TCS would decline (according to him).
  3. Now let us understand why Mr X brought a call option. The current price of the share is Rs 500/- (let) per share and after 3 months suppose the share price of TCS actually has become 700/-, then Mr A, being a call option holder, will have right to buy 1 lot of TCS shares at 500/- only. Thus Mr will make a profit of (200*1000) Rs 2,00,000/- because he held the call option of TCS Ltd.
  4. Similarly, Mr Y holds a put option so that he can make a profit if the share price of TCS would decline which he actually expected. For instance, suppose the share price decreased after 3 months to 300/- per shares but Mr Y has a put option, that means he still has rights to sell the TCS share at the rate of 500/- therefore, he will buy the shares from open market at 300/- and sell it at 500/- immediately. Thus he can make a gain of Rs 2,00,000/- due to the decline in the share price of TCS.
  5. Consider other circumstances, Mr A has call option and share price didn’t increase after 3 months instead it reduced to 400/- but he has rights to buy at 500/-. Will he exercise the call option rights? Obviously, no not at all, he will forfeit the contract, in this case, Mr A will lose his premium money.
  6. Similarly, Mr Y holds a put option and share price didn’t decrease which he expected after three months and price increased to 600/- but he holds right to sell the shares at 500/- per share. Obviously, Mr Y will also not exercise his put option, in this case, he will suffer a loss.

Conclusion:

Hope the above example will be able to get you to understand the concept of call and put options and their differences as well. In fact, a single line difference between call and put option is the kind of rights which an option holder holds whether he has rights to buy or rights to sell.

Thus we can conclude that a call option allows the option holders to buy, however, a put option provides the right to sell the underlying assets.

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Difference between Futures and Options

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Difference between IPO and FPO

 

References: call options vs put options wallstreetmojo (source)

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