What are call and put options? | Vanguard (2024)

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What are call and put options? | Vanguard? ›

Call & put options

A call option gives the buyer the right, but not any obligation, to buy a particular stock at a pre-defined price on the expiration date. A put option gives the right to an investor, but not an obligation, to sell a particular stock at a predetermined rate on the expiration date.

In regards to profitability, call options have unlimited gain potential because the price of a stock cannot be capped. Conversely, put options are limited in their potential gains because the price of a stock cannot drop below zero.

A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.

A call option is a right to buy an underlying asset or contract at a fixed price at a future date but at a price that is decided today. On the other hand, the put option is the right to sell an underlying asset or contract at a fixed price at a future date but at a price that is decided today.

A put option gives you the right to sell a specific stock at a specific price, on or before a specific date. The value of a put increases as the underlying stock value decreases. Put options can be used to try to profit from downturns, or they can be used to protect a portfolio against them.

On Jan 1, 2022, Nifty is at 16460. You buy a put option with strike price of 16500 at a premium of Rs 160 with expiry date Jan 27, 2022. A put option gives the buyer of the option the right, but not the obligation, to sell the underlying at the strike price. In this example, you can sell Nifty at 16500.

Neither is particularly better than the other; it simply depends on the investment objective and risk tolerance for the investor. Much of the risk ultimately resides in the fluctuation in market price of the underlying asset.

Call options and put options essentially come with the same degree of risk. Depending on which "side" of the contract the investor is on, risk can range from a small prepaid amount of the premium to unlimited losses. Investors who know how each work helps determine the risk of an option position.

When you sell a put option, you agree to buy a stock at an agreed-upon price. Put sellers lose money if the stock price falls. That's because they must buy the stock at the strike price but can only sell it at a lower price. They make money if the stock price rises because the buyer won't exercise the option.

Is a put bullish or bearish? ›

Conversely, buying a put option gives the owner the right to sell the underlying security at the option exercise price. Thus, buying a call option is a bullish bet—the owner makes money when the security goes up. On the other hand, a put option is a bearish bet—the owner makes money when the security goes down.

Put buyers make a profit by essentially holding a short-selling position. The owner of a put option profits when the stock price declines below the strike price before the expiration period. The put buyer can exercise the option at the strike price within the specified expiration period.

Investors may buy put options when they are concerned that the stock market will fall. That's because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset goes down.

A put allows the owner to lock in a predetermined price to sell a specific stock, while put sellers agree to buy the stock at that price.

Investors often use put options in a risk management strategy known as a protective put, which is used as a form of investment insurance or hedge to ensure that losses in the underlying asset do not exceed a certain amount.

Call options are suitable for the bullish markets. However, put options are preferred in bearish markets. Profits from call options may be unlimited. However, you will get limited profits with put options.

A rising put-call ratio, or a ratio greater than 0.7 or exceeding 1, means that equity traders are buying more puts than calls. It suggests that bearish sentiment is building in the market. Investors are either speculating that the market will move lower or are hedging their portfolios in case there is a sell-off.

Put options lose value as the underlying asset increases in price, as volatility of the underlying asset price decreases, as interest rates rise, and as the time to expiration nears.

Investors may buy put options when they are concerned that the stock market will fall. That's because a put—which grants the right to sell an underlying asset at a fixed price through a predetermined time frame—will typically increase in value when the price of its underlying asset goes down.