The market flooded with a series of investment options that allow investors to earn money when the stock market is rising or falling or going sideways. The options are one of the significant categories of derivative securities, which characterizes a contract between the parties, in which a party acquires the right to negotiate the underlying security, at an agreed price, by or before a certain date. The right to purchase a call option while when the right refers to the sale, a put option .
Calls allow you to make money when the value of financial products is increasing. On the other hand, puts will raise money when the share price of the underlying is falling. Just take a look at this article to learn more about the distinctive points between the two.
|Sense||The Call option guarantees the buyer, not the obligation, to purchase the underlying asset by a specific date for the strike price.||The Put option guarantees the right to the buyer, not the obligation, to sell the underlying asset by a specific date at the strike price.|
|What does it allow?||Purchase of stock||Shares sale|
|Relationship with the stock market||Direct||Reverse|
|The investor seeks||Price increase||Fall in prices|
Definition of the call option
A derivative contract between buyer and seller in which the buyer is offered the right to purchase the underlying asset, by a certain date at the exercise price. When you purchase a call option, you acquire the right to purchase the financial product by or before a specific date in the future, at a fixed price. For this, it is necessary to pay an initial cost in the form of premium.
When the buyer exercises his option to purchase the stock option from call, the seller obliged to sell the stock, at the price previously agreed by the parties. All stock market instruments are covered by the call option, such as stocks, bonds, currencies, commodities and much more.
Definition of the Put option
A put option defined as an option contract between two parties, buyer and seller, based on which the buyer has the right to sell the underlying asset by a certain date at the strike price. The option buyer must pay the premium to earn that right. When you buy a put option, you earn the right to sell the shares, by or before a certain future date, at a set price.
Once the buyer exercises his right option to sell the underlying asset, the seller has no choice but to buy the asset at the agreed price. Thus, the seller is obliged to purchase the financial instrument. In other words, the opposite of a call option is a put option.
Key differences between the Call and Put option
The main differences between the call and put options are shown below in the following points:
- The right in the hands of the buyers to buy the underlying security by a specific date for the exercise price, but not obliged to do so, known as the Call option. The right in the hands of the buyer to sell the underlying security by a specific date for the exercise price, but not obliged to do so, known as the Put option.
- A call option allows the purchase of an option, while the Put option allows the sale option.
- The call generates money when the value of the underlying asset increases while Put makes money when the value of the securities is decreasing.
- The potential gain in the event of an unlimited call option, but this limited gain in the put option.
- In the call option, the investor seeks to increase the stock price. On the contrary, in the put option the investor expects stock prices to fall.
Some similar aspects are present in the two investments, as both acts as an agreement between buyer and seller in the financial market, where time works as an essence of the contract, meaning that the option must be exercised before time runs out. Furthermore, losses in both cases are limited to the amount paid on the premium.
Suppose that A (buyer) purchases a call option and enters into a contract with B (seller) that acquires 1000 shares at Rs. 200 per share of Alpha Ltd. after three months, and pays a Rs. 5000 for the same. If after three months the share prices are Rs. 220 therefore A can buy shares from B to Rs. 200 exercising the right and B obliged to pay the same while if the prices fall to 180 then A does not buy the same from B because he will be able to buy the same from any other person at Rs. 180 from any other person on the market.
Put the option
Suppose that A (buyer) purchases a put option and enters into a contract with B (seller) to sell 1000 Rs shares. 200 per share of Alpha Ltd. (this price prevails on the market) after three months from the date. A pays a premium for this, of Rs. 5000. Before the deadline expires, the company price drops to Rs. 180 per share, so A can buy the shares from the stock market of Rs. 180 per share and sell them to B to Rs. 200 per share. However, if the share price rises to Rs. 220, so it is not necessary to buy it at a high rate by selling it at a low rate, since in the end this is equivalent to a loss for A.
When you invest in a call option, you always expect that the price will increase to get more and more profits, while if you opt for a put option you want the prices to decrease because only then you will be able to earn profits or otherwise you will suffer a loss up to the limit of the premium paid. Call option and put option are the two exact opposite terms.