Main Difference – Call vs Put Option
The financial market in an economy consists of different kinds of financial instruments. Investors invest their surplus on financial derivatives and financial institutes, as intermediaries use these surplus funds to underwrite loans for the deficit units. Thus, options market has become very important in the world of finance and investment market. Options are a type of financial derivative trade in both exchange and over-the-counter market. Primarily options are classified as European option and American option. These options are further divided into two categories know as call option and put option. The main difference between call and put options is based on the ‘right’ that the holder has to bare; in call options, the buyer has the right to buy the shares at the pre-defined price at the time of maturity whereas, in put options, the buyer has the right to sell the assets at the pre-defined price.
This article covers,
1. What is Call Option?
– Definition, Rights, When to Use, and Profit
2. What is Put Option?
– Definition, Rights, When to Use, and Profit
3. What are the similarities between Call and Put Options?
4. What is the difference between Call and Put Options?
What is Call Option
A call option gives the holder the right, but not the obligation to buy an asset (stock) in the future at a predetermined price. Here the buyer buys the option, paying a premium to the seller of the call option and make a contract to buy the asset at an agreed future time. A buyer of a call option will buy a call option believing that the prices of the underlying asset will increase in the future. If the market price of the asset has been increased at the time of expiration of the option, the buyer of the call option will decide to exercise the option; thus he / she can buy the intended asset at a lower price (at the contracted price / strike price) than the current market price. However, if the market price of the asset is decreasing, the buyer of the call option does not exercise the option. Hence, the maximum loss for the buyer of the call option in this situation is the premium that he / she paid at the time of the agreement.
What is Put Option
A put option gives the holder the right, but not the obligation to sell an asset (stock) at a future date at a pre-determined price. Here also the buyer of the put option pays a premium to the seller at the beginning of the contract. The buyer of the put options buys the put contract, believing that the prices of the asset will decrease in future. Accordingly, if the price of the underlying asset reduces at the expiration time, the buyer of the call option will decide to exercise the option; thus, the put option holder will sell his / her assets at a higher price than the continuing market price. However, if the market price of the underlying asset is increasing, the holder of the put option will not exercise the put option; instead, he would sell the asset in the open market to acquire more money. Thus, the maximum loss for the buyer of a put option would be the premium amount paid to buy that put option.
Similarities Between Call Option and Put Option
Both are types of securities that give the holder the right, but not the obligation to exercise the option. In both situations, the term ‘holder’ indicates the holder of the right, but not the physical asset.
In both situations, buyer of the option pays a premium to the seller (writer) of the option. The purpose of this payment is to partially recover the risk of price fluctuations.
Difference Between Call and Put Options
Call option: The buyer has the right to buy the shares at the pre-defined price at the time of maturity.
Put option: The buyer has the right to sell the assets at the pre-defined price.
When to Use
Call option: Call option will be exercised when the market price of underlying asset increases.
Put option: Put option will be used when the market price of the asset decreases.
Call option: The seller has the asset or required amount of investment to buy the assets.
Put option: The buyer has the asset or required amount of investment to buy the assets prior to the exercise of the option.
Call option: The profit would be
market price – strike price – premium
Put option: The profit would be
strike price – market price – premium
Call vs Put Option Conclusion
Options are a type of financial securities that can be used against market price fluctuations of the underlying assets. Call options give the buyer the right to buy assets, whereas put option gives the buyer to sell the assets at an agreed price in future times. Buying a call option can be used as a strategy if the market prices of the assets show an increasing trend. On the other hand, buying a put option can be used if the prices are decreasing.
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