The details of CALL & PUT options

What are European and American Style of options?
An American style option is the one which can be exercised by the buyer on or before the expiration date, i.e. anytime between the day of purchase of the option and the day of its expiry.

The European kind of option is the one which can be exercised by the buyer on the expiration day only & not anytime before that.

What are Call Options?
A call option gives the holder (buyer/ one who is long call), the right to buy specified quantity of the underlying asset at the strike price on or before expiration date.

The seller (one who is short call) however, has the obligation to sell the underlying asset if the buyer of the call option decides to exercise his option to buy.

Example: An investor buys One European call option on Infosys at the strike price of Rs. 3500 at a premium of Rs. 100. If the market price of Infosys on the day of expiry is more than Rs. 3500, the option will be exercised.

The investor will earn profits once the share price crosses Rs. 3600 (Strike Price + Premium i.e. 3500+100).

Suppose stock price is Rs. 3800, the option will be exercised and the investor will buy 1 share of Infosys from the seller of the option at Rs 3500 and sell it in the market at Rs 3800 making a profit of Rs. 200 { (Spot price - Strike price) - Premium}.

In another scenario, if at the time of expiry stock price falls below Rs. 3500 say suppose it touches Rs. 3000, the buyer of the call option will choose not to exercise his option. In this case the investor loses the premium (Rs 100), paid which shall be the profit earned by the seller of the call option.

What are Put Options?
A Put option gives the holder (buyer/ one who is long Put), the right to sell specified quantity of the underlying asset at the strike price on or before a expiry date.

The seller of the put option (one who is short Put) however, has the obligation to buy the underlying asset at the strike price if the buyer decides to exercise his option to sell.

Example: An investor buys one European Put option on Reliance at the strike price of Rs. 300/-, at a premium of Rs. 25/-. If the market price of Reliance, on the day of expiry is less than Rs. 300, the option can be exercised as it is 'in the money'.

The investor's Break even point is Rs. 275/ (Strike Price - premium paid) i.e., investor will earn profits if the market falls below 275.

Suppose stock price is Rs. 260, the buyer of the Put option immediately buys Reliance share in the market @ Rs. 260/- & exercises his option selling the Reliance share at Rs 300 to the option writer thus making a net profit of Rs. 15 {(Strike price - Spot Price) - Premium paid}.

In another scenario, if at the time of expiry, market price of Reliance is Rs 320/ - , the buyer of the Put option will choose not to exercise his option to sell as he can sell in the market at a higher rate. In this case the investor loses the premium paid (i.e Rs 25/-), which shall be the profit earned by the seller of the Put option.


How are options different from futures?

The significant differences in Futures and Options are as under:

Futures are agreements/contracts to buy or sell specified quantity of the underlying assets at a price agreed upon by the buyer and seller, on or before a specified time. Both the buyer and seller are obligated to buy/sell the underlying asset.

In case of options the buyer enjoys the right and not the obligation, to buy or sell the underlying asset.

Futures Contracts have symmetric risk profile for both buyers as well as sellers, whereas options have asymmetric risk profile.

In case of Options, for a buyer (or holder of the option), the downside is limited to the premium (option price) he has paid while the profits may be unlimited.

For a seller or writer of an option, however, the downside is unlimited while profits are limited to the premium he has received from the buyer.

The futures contracts prices are affected mainly by the prices of the underlying asset. Prices of options are however; affected by prices of the underlying asset, time remaining for expiry of the contract and volatility of the underlying asset.

It costs nothing to enter into a futures contract whereas there is a cost of entering into an options contract, termed as Premium.