Call and Put Options Definitions and Examples

A Guide to Call and Put Options

Pracekladno 2018  

Call and put options are derivative investments, meaning their price movements are based on the price movements of another financial product, which is often called the underlying. A call option is bought if the trader expects the price of the underlying to rise within a certain time frame. A put option is bought if the trader expects the price of the underlying to fall within a certain time frame. Puts and calls can also be written/sold, which generates income but gives up certain rights to the buyer of the option.

Breaking Down the Call Option

For U.S.-style options, a call is an options contract that gives the buyer the right to buy the underlying asset at a set price at any time up to the expiration date. Buyers of European-style options may exercise the option—buy the underlying—only on the expiration date.

The strike price is the predetermined price at which a call buyer can buy the underlying asset. For example, the buyer of a stock call option with a strike price of 10 can use the option to buy that stock at $10 before the option expires.

Options expirations vary and can be short-term or long-term. It is worthwhile for the call buyer to exercise their option, and require the call writer/seller to sell them the stock at the strike price, only if the current price of the underlying is above the strike price.

For example, if the stock is trading at $9 on the stock market, it is not worthwhile for the call option buyer to exercise their option to buy the stock at $10 because they can buy it for a lower price on the market.

The call buyer has the right to buy a stock at the strike price for a set amount of time. For that right, the call buyer pays a premium. If the price of the underlying moves above the strike price, the option will be worth money (will have intrinsic value). The buyer can sell the option for a profit (this is what most call buyers do) or exercise the option at expiry (receive the shares).

The call writer/seller receives the premium. Writing call options is a way to generate income. However, the income from writing a call option is limited to the premium, while a call buyer has theoretically unlimited profit potential.

One stock call option contract actually represents 100 shares of the underlying stock. Stock call prices are typically quoted per share. Therefore, to calculate how much buying the contract will cost, take the price of the option and multiply it by 100. 

Call options can be in, at, or out of the money. In the money means the underlying asset price is above the call strike price. Out of the money means the underlying price is below the strike price. At the money means the underlying price and the strike price are the same.

You can buy a call in any of those three phases. Your premium will be larger for an in the money option, because it already has intrinsic value.

Breaking Down the Put Option

For U.S.-style options, a put is an options contract that gives the buyer the right to sell the underlying asset at a set price at any time up to the expiration date. Buyers of European-style options may exercise the option—sell the underlying—only on the expiration date.

The strike price is the predetermined price at which a put buyer can sell the underlying asset. For example, the buyer of a stock put option with a strike price of 10 can use the option to sell that stock at $10 before the option expires.

It is worthwhile for the put buyer to exercise their option, and require the put writer/seller to buy the stock from them at the strike price, only if the current price of the underlying is below the strike price.

For example, if the stock is trading at $11 on the stock market, it is not worthwhile for the put option buyer to exercise their option to sell the stock at $10 because they can sell it for a higher price on the market. 

The put buyer has the right to sell a stock at the strike price for a set amount of time. For that right, the put buyer pays a premium. If the price of the underlying moves below the strike price, the option will be worth money (will have intrinsic value). The buyer can sell the option for a profit (what most put buyers do) or exercise the option at expiry (sell the shares).

The put seller/writer receives the premium. Writing put options is a way to generate income. However, the income from writing a put option is limited to the premium, while a put buyer's maximum profit potential occurs if the stock goes to zero.

One stock put option contract actually represents 100 shares of the underlying stock. Stock put prices are typically quoted per share. Therefore, to calculate how much buying the contract will cost, take the price of the option and multiply it by 100.

Put options can be in, at, or out of the money. In the money means the underlying asset price is below the put strike price. Out of the money means the underlying price is above the strike price. At the money means the underlying price and the strike price are the same.

You can buy a put option in any of those three phases. Your premium will be larger for an in the money option, because it already has intrinsic value.