TWO FLAVOURS OF OPTIONS
CALL
OPTION & PUT OPTION
Never trade options as an instrument of speculation. It is very important to understand the basic fundamentals of options and why were they created in the first place?
Let
me start with a Call Option. What is a Call Option?
As the name suggest "Call" means you are calling "something". Here that something is STOCKS.
When
you buy a Call Option you are in fact buying the "Right to Call the stock away from someone".
Buying a Call Option gives you the Right to Call the stock away from someone
In the above example
CE
represents a Call Option
And
when you buy this Call Option you are buying the “Right to Buy” one lot
of Tatamotors shares by the end of February series at a price of Rs. 440 and
you are paying the premium of Rs. 11 per share to buy this option.
Let's say Tatamotors is trading at 450 and your view is bullish, but you are not very sure about it and don't want to take much risk, then instead of buying stocks directly in cash market , you may very well buy a 450 Call Option.
Now if your view is right and by the end of expiry Tatamotors is trading at 470 than you can exercise your right and call (buy) the stocks at a price of 450, whereas CMP of Tatamotors is 470.
Say, if your view is wrong and by the end of expiry Tatamotors is trading at 430 than you don't have the obligation to call (buy) the stocks. Your loss is limited only to the premium that you have paid to the seller.
Advantage of buying Call Option is that, it helps you to confirm the uptrend in stock and allows you to buy this stock at old price which was prevailing before the up move in stock price. It also protects your capital in case your view is wrong. But this advantage comes at a premium which you pay to the option seller.
For
an option seller it’s exactly opposite, Call Option seller has the obligation
to sell a specific stock at a specific price within a specific time frame. That
also means that during the time of expiry Call Option seller should have shares
with him to give delivery.
Now let’s talk about Put Option.
As the name suggest "Put" means you are putting/dumping the stocks on someone.
When you buy a Put Option you are in fact buying the "Right to put/dump the stock” on someone.
Buying a Put Option gives you the Right to Put / Dump the stock on someone
As the standard definition goes "Buying a Put Option gives you the right (but not the obligation) to sell a specific stock at a specific price within a specific time frame.
Let’s
take an example of Tatamotors here.
You
own one lot of Tatamotors share at 450 and you fear that stock may fall for some
reason and you want to protect your investment. In this case you may buy a 450 Put
Option.
Now if stock price falls to say 430 by the end of expiry than you can exercise your right and put (sell) the stocks at a price of 450, whereas CMP of Tatamotors is 430.
Say, if your view is wrong and by the end of expiry Tatamotors is trading at 470 than you don't have the obligation to Put (sell) the stocks. You can continue to enjoy the gains in stock price.
Advantage of buying Put Option is that, it helps you to confirm the downtrend in stock and allows you to sell this stock at old price which was prevailing before the down move in stock price. It also helps to protects your capital in case there is any down move in the stock you own. But again this advantage comes at a premium which you have to pay to the option seller.
For
an option seller again it’s exactly opposite, Put Option seller has the
obligation to buy a specific stock at a specific price within a specific time
frame. Put Option is used by option sellers to buy stocks at lower price.
Conclusion
- Call Option is used to call stocks away from someone
- Put Option is used to put or dump stocks on someone
- Good quality stocks which are in uptrend can be bought at lower price using a call option and poor quality stocks which are in downtrend can be dumped at higher price using a put option.
- For an option seller, Call options can be used to sell stocks which have peaked out and put option is used to buy stocks which have bottomed out.
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Disclaimer:- The article is for educational purpose only. Please consult your financial advisor before making any investment decision.
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