What does put and call option mean
Further we looked at four different variants originating from these 2 options —. Think of it this way — if you give a good artist a color palette and canvas he can create some really interesting paintings, similarly a good trader can use these four option variants to create some really good trades.
Imagination and intellect is the only requirement for creating these option trades. Hence before we get deeper into options, it is important to have a strong foundation on these four variants of options.
For this reason, we will quickly summarize what we have learnt so far in this module. Arranging the Payoff diagrams in the above fashion helps us understand a few things better. Let me list them for you —. Going by that, buying a call option and buying a put option is called Long Call and Long Put position respectively. Going by that, selling a call option and selling a put option is also called Short Call and Short Put position respectively.
However I think it is best to reiterate a few key points before we make further progress in this module. Buying an option call or put makes sense only when we expect the market to move strongly in a certain direction.
If fact, for the option buyer to be profitable the market should move away from the selected strike price. Selecting the right strike price to trade is a major task; we will learn this at a later stage. For now, here are a few key points that you should remember —. The option sellers call or put are also called the option writers. Selling an option makes sense when you expect the market to remain flat or below the strike price in case of calls or above strike price in case of put option.
I want you to appreciate the fact that all else equal, markets are slightly favorable to option sellers. This is because, for the option sellers to be profitable the market has to be either flat or move in a certain direction based on the type of option. However for the option buyer to be profitable, the market has to move in a certain direction.
Clearly there are two favorable market conditions for the option seller versus one favorable condition for the option buyer. But of course this in itself should not be a reason to sell options.
This means to say that the option writers earn small and steady returns by selling options, but when a disaster happens, they tend to lose a fortune. Well, with this I hope you have developed a strong foundation on how a Call and Put option behaves.
Just to give you a heads up, the focus going forward in this module will be on moneyness of an option, premiums, option pricing, option Greeks, and strike selection. Once we understand these topics we will revisit the call and put option all over again.
This information is highlighted in the red box. Below the red box, I have highlighted the price information of the premium. If you notice, the premium of the CE opened at Rs.
Moves like this should not surprise you. These are fairly common to expect in the options world. Assume in this massive swing you managed to capture just 2 points while trading this particular option intraday. This translates to a sweet Rs. In fact this is exactly what happens in the real world. Traders just trade premiums. Hardly any traders hold option contracts until expiry. Most of the traders are interested in initiating a trade now and squaring it off in a short while intraday or maybe for a few days and capturing the movements in the premium.
They do not really wait for the options to expire. These details are marked in the blue box. Below this we can notice the OHLC data, which quite obviously is very interesting. The CE premium opened the day at Rs. However assume you were a seller of the call option intraday and you managed to capture just 2 points again, considering the lot size isthe 2 point capture on the premium translates to Rs.
However by no means I am suggesting that you need not hold until expiry, in fact I do hold options till expiry in certain cases. Generally speaking option sellers tend to hold contracts till expiry rather than option buyers. This is because if you have written an option for Rs. So having said that the traders prefer to trade just the premiums, you may have a few fundamental questions cropping up in your mind. Why do premiums vary?
What is the basis for the change in premium? How can I predict the change in premiums? Who decides what should be the premium price of a particular option?
Well, these questions and therefore the answers to these form the crux of option trading. To give you a heads up — the answers to all these questions lies in understanding the 4 forces that simultaneously exerts its influence on options premiums, as a result of which the premiums vary. Think of this as a ship sailing in the sea. The speed at which the ship sails assume its equivalent to the option premium depends on various forces such as wind speed, sea water density, sea pressure, and the power of the ship.
Some forces tend to increase the speed of the ship, while some tend to decrease the speed of the ship. The ship battles these forces and finally arrives at an optimal sailing speed. Crudely put, some Option Greeks tends to increase the premium, while some try to reduce the premium. Try and imagine this — the Option Greeks influence the option premium however the Option Greeks itself are controlled by the markets.
As the markets change on a minute by minute basis, therefore the Option Greeks change and therefore the option premiums! Going forward in this module, we will understand each of these forces and its characteristics. We will understand how the force gets influenced by the markets and how the Option Greeks further influences the premium. We will do the same in the next chapter. A quick note here — the topics going forward will get a little complex, although we will try our best to simplify it.
While we do that, we would request you to please be thorough with all the concepts we have learnt so far. Thanks a lot for sharing learning material, it is really helpful for beginners like me to understand the concept and strategy of share market. We are trying out best to complete the modules as fast as we can.
European option means the settlement is on expiry day. However, you can just speculate on option premiums…and by virtue of which, you can hold the position for few mins or days. Also we have potential of unlimited profit in long call or long put and even we can trail stoploss of premiums.
Thank you so much for your articles sir. Cause sitting in front of computer is not possible. Even if we r there we may miss the trade id doing some thing else at the time we are suppose to trade or squareoff the tyrade. Till now it has been very clear and crisp. Thanks for that and hope that further chapters will also come the same way.
We will be discussing SL based on Volatility very soon. Request you to kindly stay tuned till then. We certainly hope to keep the future chapters as easy and lucid as the previous ones have been. Hi Really nice initiative sir. Hello Sir, if I buy a lot ofcall option of strike price at a premium of Rs 2 with a spot price of Now if the price moves to and premium is now at 3 so would be my profit?? Firstly, if the spot moves from tothe premium of the Call option will certainly be more than Rs.
Your profits would be —. Hello Sir, I am still confused with the way the profit is calculated. Might be, I am not able to get what u explained and I am really sorry for asking it again. In some of your replies, you mentioned that the profit is calculated as per the difference of spot price and strike price and in some replies u mentioned that it is as per the difference of premium.
In case of 1 lot of shares the profit would be. So which of the above options are correct??? Is there a difference if I am closing my position before expiry or excersize it at expiry? For all practical purposes I would suggest you use the 2nd way of calculating profits…i. Do remember the premium paid for this option is Rs 6. Irrespective of how the spot value changes, the fact that I have paid Rs. This is the cost that I have incurred in order to buy the Call Option.
Please note — the negative sign before the premium paid represents a cash out flow from my trading account. This lead to my confusion. Got your point, see if you are holding the option till expiry you will end up getting the amount equivalent to the intrensic value of the option. I have explained more on this in the recent chapter on Theta…but I would suggest you read up sequentially and not really jump directly to Theta.
The calculation provided by karthik in chapter 3 is for expiry calculation on expirt date. Hope this clears your doubt. The minimum value for this option should be STT stands for Security Transaction Tax, which is levied by the Government whenever a person does any transaction on the exchange.
In finance, a put or put option is a stock market device which gives the owner of a put the right, but not the obligation, to sell an asset the underlyingat a specified price the strikeby a predetermined what does put and call option mean the expiry or maturity to a given party the seller of the put.
The purchase of a put option is interpreted as a negative sentiment about the future value of the underlying. Put options are most commonly used in the stock market to protect against the decline of the price of a stock below a specified price. In this way the buyer of the put will receive at least the strike price specified, even if the asset is currently worthless.
If the strike is Kand at time t the value of the underlying is S tthen in an American option the buyer can exercise the put for a payout of K-S t any time until the option's maturity time T.
The put yields a positive return only if the security price falls below the strike when the option is exercised.
A European option can only be exercised at time T rather than any time until Tand a Bermudan option can be exercised only on specific dates listed in the terms of the contract. If the option is not exercised by maturity, it expires worthless. The buyer will not exercise the option at an allowable date if the price of the underlying is greater than K. The most obvious use of a put is as a type of insurance. In the protective put strategy, the investor buys enough puts to cover his holdings of the underlying so that if a drastic downward movement of the underlying's price occurs, he has the option to sell the holdings at the strike price.
Another use is for speculation: Puts may also be combined with other derivatives as part of more complex investment strategies, and in particular, may be useful for hedging. By put-call paritya European put can be replaced by buying the appropriate call option and selling an appropriate forward contract. The terms for exercising the option's right to sell it differ depending on option style. A European put option allows the holder to exercise the put option for a short period of time right before expiration, while an American put option allows exercise at any time before expiration.
The put buyer either believes that the underlying asset's price will fall by the exercise date or hopes to protect a long position in it. The advantage of buying a put over short selling the asset is that the option owner's risk of loss is limited to the premium paid for it, whereas the asset short seller's risk of loss is unlimited its price can rise greatly, in fact, in theory it can rise infinitely, and such a rise is the short seller's loss.
The what does put and call option mean writer believes that the underlying security's price will rise, not fall. The writer sells the put to collect the premium. The put writer's total potential loss is limited to the put's strike price less the spot and premium already received.
Puts can be used also to limit the writer's portfolio risk and may be part of an option spread. That is, the buyer wants the value of the put option to increase by a decline in the price of the underlying asset below the strike price. The writer seller of a put is long on the underlying asset and short what does put and call option mean the put option itself.
That is, the seller wants the option to become worthless by an increase in the price of the underlying asset above the strike price. Generally, a put option that is purchased is referred to as a long put and a put option that is sold is referred to as a short put. A naked putalso called an uncovered putis a put option whose writer the seller does not have a position in the underlying stock or other instrument.
This strategy is best used by investors who want to accumulate a position in the underlying stock, but only if the price is low enough. If the buyer fails to exercise the options, then the writer keeps the option premium as a "gift" for playing the game. If the underlying stock's market price is below the option's strike price when expiration arrives, the option owner buyer can exercise the put option, forcing the writer to buy the underlying stock at the strike price.
That allows the exerciser buyer to profit from the difference between the stock's market price and the option's strike price. But if the stock's market price is above the option's strike price at the end of expiration day, the option expires worthless, and what does put and call option mean owner's loss is limited to the premium fee paid for it the writer's profit. The seller's potential loss on a naked put can be substantial. If the stock falls all the way to zero bankruptcyhis loss is equal to the strike price at which he must buy the stock to cover the option minus the premium received.
The potential upside is the premium received when selling the option: What does put and call option mean the option's lifetime, if the stock moves lower, the option's premium may increase depending on how far the what does put and call option mean falls and how much time passes. If it does, it becomes what does put and call option mean costly to close the position repurchase the put, sold earlierresulting in a loss.
If the stock price completely collapses before the put position is closed, the put writer potentially can face catastrophic loss. In order to protect the put buyer from default, the put writer is required to post margin. The put buyer does not need to post margin because the buyer would not exercise the option if it had a negative payoff.
A buyer thinks the price of a stock will decrease. He pays a premium which he will never get back, unless it is sold before it expires. The buyer has the right to sell the stock at the strike price.
The writer receives a premium from the buyer. If the buyer exercises his option, the writer will buy the stock at the strike price. If the buyer does not exercise his option, the writer's profit is the premium. A put option is said to have intrinsic value when the underlying instrument has a spot price S below the option's strike price K. Upon exercise, a put option is valued at K-S if it is " in-the-money ", otherwise its value is zero.
Prior to exercise, an option has time value apart from its intrinsic value. The following factors reduce the time value of a put option: Option pricing is a what does put and call option mean problem of financial mathematics. Trading options involves a constant monitoring of the option value, which is affected by changes in the base asset price, volatility and time decay. Moreover, the dependence of the put option value to those factors is not linear — which makes the analysis even more complex.
The graphs clearly shows the non-linear dependence of the option value to the base asset price. From Wikipedia, the free encyclopedia. This article needs additional citations for verification. Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. November Learn how and when to remove this template message. Energy derivative Freight derivative Inflation derivative Property derivative Weather derivative.
A call optionoften simply labeled what does put and call option mean "call", is a financial contract between two parties, the buyer and the seller of this type of option. The seller or "writer" is obligated to sell the commodity or financial instrument to the buyer if the buyer so decides.
The buyer pays a fee called a premium for this right. The term "call" comes from the fact that the owner has the right to "call the stock away" from the seller. Option values vary with the value of the underlying instrument over time. The price of the call contract must reflect the "likelihood" or chance of the call finishing in-the-money.
The call contract price generally will be higher when the contract has more time to expire except in cases when a significant dividend is present and when the underlying financial instrument shows more volatility. Determining this value is one of the central functions of financial mathematics.
The most common method used is the Black—Scholes formula. Importantly, the Black-Scholes formula provides an estimate of the price what does put and call option mean European-style options. Adjustment to Call Option: When a call option is in-the-money i. Some of them are as follows:. Similarly if the buyer is making loss on his position i.
Trading options involves a constant monitoring of the option value, which is affected by the following factors:. Moreover, the dependence of the option value to price, volatility and time is not linear — which makes the analysis even more complex. From Wikipedia, the free encyclopedia. This article is about financial options. For call options in general, see Option law. This article needs additional citations for verification.
Please help improve this article by adding citations to reliable sources. Unsourced material may be challenged and removed. October Learn how and when to remove this template message. Upper Saddle River, New Jersey A Practical Guide for Managers.