If you are an investor and have never heard about option trading? That could be the reason that many investors find option trading very complex and heft as it consists of various terms and strategies. Understanding what is options trading? What are Call and Put Options? understanding them is important for making informed trading decisions.
Options trading is a process that involves buying and selling but not the obligation, the contracts to buy or sell an underlying asset at a predetermined price. The Call option enables the buying of the asset, whereas the pull option enables the selling of the asset.
In this blog you will know all about what is options trading? What Are Call and Put Options: Differences and Terms related to them.
What Is Options Trading?
So the first question that will come to your mind is what are options? So you must have heard somewhere that options are derivative. Here, the most complex word that comes out is derivative. If you understand the derivative, then you will also understand the options. So derivative, basically, we call everything whose value is derived from something else.
Let us understand what are options with an example, So suppose you contract to buy a flat. The value of the flat is 50 lakh rupees and to buy it, you give an advance of 1 lakh rupees. Now the next day of buying your flat happens that where you had contracted to buy a flat, a very big mall starts being built in the same location.
So now it is obvious that the value of the flat will increase and let’s assume that it increases to 1 crore rupees. Now in this case, if your friend tells you that he wants to buy the flat that you have booked, then give him the booking that you have booked, he will give you your 1 lakh rupees.
So will you give your friend the booking or contract by giving only 1 lakh rupees? No, because you know that now the value of that flat has increased so according to this, the value of your contract has also increased. So now you will tell him that the value of this contract is 1 lakh rupees but the price of the flat has increased to 1 crore rupees. Whereas with this 1 lakh rupees contract, you will get that flat in 50 lakh rupees and you will get a real profit of 50 lakh rupees.
In this case, you will demand 10 lakh rather than 1 lakh, since the value of the flat has now increased to 1 crore. So in this case, this contract worth 1 lakh rupees is a derivative whose value depends on that flat. If the value of the flat increases, then the value of this contract also increases.
What Are Call And Put Options?
Now, it is important for you to understand the put and call contract. So, call is called call European and put is called put European. But generally, it is called call and putty or it is called call and putty. So, let’s understand it from the perspective of the option buyer.
Suppose, there is a stock XYZ and you think that the price of this stock will increase then you will buy its call option. That means whenever you want to increase the price of a stock then you buy the call option. And if you think that the price of a stock will decrease then in this case you have to buy the put option. That means you have to buy the PE option.
Difference Between Call And Put Options
| Characteristic | Call Option | Put Option |
|---|---|---|
| Definition | Right to buy an asset at a specified price | Right to sell an asset at a specified price |
| Profit Potential | Unlimited | Limited |
| Loss Potential | Limited | Unlimited |
| Market Outlook | Bullish | Bearish |
| Payoff Structure | Increasingly profitable with rising prices | Increasingly profitable with falling prices |
| Breakeven Point | Strike price + Premium | Strike price – Premium |
| Usage | Speculation, hedging, covered calls | Speculation, hedging, protective puts |
| Risk Level | Moderate to high | Moderate to high |
| Time Decay | Negative | Negative |
Terms Related To Call And Put Options
| Term | Description |
|---|---|
| Spot Price | The price at which the buyer can buy or sell the asset |
| Strike Price | The date on which the option contract expires |
| Option Premium | Non-refundable amount paid by the buyer to the seller |
| Option Expiry | Date on which the option contract expires |
| Settlement | Method of settling the option contract, typically cash |