Options are contracts that entitle the holder with a choice, and not an obligation, to buy or sell an underlying asset at a predetermined price prior to the expiry of contract. If the option contract is profitable to the buyer, they are likely to avail it, and if not – the option is unlikely to be exercised. The price at which the two parties come into contract is known as a strike price.
There are two types of options:
Call option
The call option is the option that allows the holder to buy a security at a predetermined price before the date of expiry of contract. This is similar to a down payment for a purchase at a later date. For instance, if Mr X buys a call option to buy 10 units of Security S at price ₹50, then he has the option, but not an obligation, to buy the units at ₹50 from the seller of the option. If the market price is higher, he will avail the option of buying the stock at predetermined price, but if the market price is lower – he would rather buy it from the market. However, whatever he decides to do, he will factor in the premium he paid to buy the option.
Put option
The put is an option that allows the holder to sell a security at a predetermined price prior to the expiry date. For instance, if Mr X buys a put option to sell security ‘S’ before June 30 at price 50, then he has the option to sell ‘S’ at ₹50 to the seller before that date. If the market price is higher, he will not avail the option, but if the market price is lower, then he will avail it.
However, whatever he decides to do, he will also factor in the premium he paid to buy the option.
To summarise, put option is the option given to the holder to sell a security at a pre-decided price, whereas call option is the option given to the holder to buy a security at a predetermined price later.