What are Call and Put Options

Having learned the basics of options trading, Raghav now feels prepared to learn about the two most important concepts that would help him understand and stay tuned with options trading, which are call options and put options. Let us break this down in a simple way.

What is a call option?

A call option gives the buyer, but not the obligation, a right to buy an underlying asset, such as stocks, at a predetermined price, otherwise known as a strike price, by a predetermined date, usually called an expiry date.

Suppose, for illustration, Reliance Industries is trading at ₹2,000 a share. You buy a call option with a strike price of ₹2,200, expecting the stock to rise in the future. The stock price rises to ₹2,500 and you can exercise your option to buy it at ₹2,200 and sell at ₹2,500, hence earning a profit of ₹300 per share minus the premium paid for the option.

The advantage here is that you can benefit from the price increase without actually owning the stock.

What's a Put Option?

The Put Option does the opposite. It gives you the right to sell stock at a given price if you think the price will fall.

For instance, you have one HDFC Bank stock at ₹1,500 and are worried it might fall. You buy a put option with a strike price of ₹1,400. Now, if your stock goes down to ₹1,200, you will sell at ₹1,400, saving you from the loss.

Put options are one more excellent means for hedging against loss, especially in case of slipping market prices.

How Calls and Puts Help Traders

Options can be used in various ways, both with call and put options:

1. Speculation: Traders buy call options if they expect the price of the stock to increase or buy put options if it is expected to fall.

2. Hedging: It involves the use of a put option to guard one's portfolio against possible losses when the market starts falling.

3. Income Generation: More experienced traders may consider selling options to collect premiums, though associated with more risk.

The Risk Factor

Yes, it's a high potential for profit type of trading, but always comes with risk. If you buy an option, the most you will lose is the premium that you paid for it, regardless of what happens in the market. If you sell options, however, your risk is much higher if the market goes against you.

Conclusion

The understanding of Call and Put options was a big leap for Raghav in order to be a successful trader. These options introduced him to a way of making money without actually owning the stock, but risks were also involved, for which one needed to be well-planned. Similar to Raghav, anyone can get into the world of options trading. Of course, if they want to make an effort to learn and gain practice before diving in, they should be more aware than just jumping in with a loaded gun. Options trading itself is all about risk management and making the right informed decisions.

Now that you are familiar with the basics of calls and puts, in the next chapter, let's dive into one of the most popular strategies, which is covered calls. This involves selling call options on a stock that one currently hols to receive additional income.