Call Option vs. Put Option: Buy Low, Sell High!

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Difference between Call Option and Put Option

The financial world is a vast and mysterious place filled with confusing terms and bewildering nomenclature. The call option and the put option are both particularly difficult to come to terms with, although they do have similarities in that they are essentially two types of financial instruments that enable holders to either purchase or sell underlying securities at a predetermined price. In addition, both options are subject to limited terms, and this means that the trader will have to make a decision before the term expires.

Call Option
Put Option

Definition

A call option is basically a contract in which the buyer has the option to purchase a certain stock if it manages to reach a pre-agreed price. In this type of arrangement, the seller is legally obliged to sell off the stock in the event that the pre-agreed price is reached.

A put option is quite similar to the call option, although its function is actually the opposite. In this type of arrangement, the buyer will have the option to sell if the stock reaches the pre-agreed price, while the seller of the stock is legally obliged to buy the stock once it has reached that price.

In Use

In a call option, the call buyer intends to make a profit when the price of the stocks goes up, in which case the call price will increase correspondingly. The call writer in this case is hoping for the opposite scenario, in which the stock price will go down, or at least go up to a level that is lower than the amount that was received for selling the call.

In the put option, the buyer of the stock will make a profit in the event that the stock price goes down. This is because the put goes up in value when the underlying stock goes down in value. In the same way, the put writers are hoping for a scenario in which they have the option to get stock price higher than the strike price, or at least one in which the price of the stock goes down lower than what they were paid to sell the put.

Relative Advantages And Disadvantages

Both the call option and the put option come with a share of risks and rewards, and the decision to go with one or the other depends on the strategic intent. Buyers of options are said to have long positions, while sellers are said to have a short positions. Call options may give investors considerable gains if the price of the stock goes up quickly in a relatively short period. If the stock closes at a low amount however, investors may lose a considerable amount of money on the trade.

Similarities and Differences

Call option

  • A contract in which the buyer has the option to purchase a certain stock if it manages to reach a pre-agreed price
  • Seller is legally obliged to sell off the stock in the event that the pre-agreed price is reached

Put option

  • Buyer will have the option to sell if the stock reaches the pre-agreed price
  • Seller of the stock is legally obliged to buy the stock once it has reached that price

Which one will gain value when the stock price declines?
  • Call Option
  • Put Option
 
 

Discuss It: comments 4

  • Guest
  • commodity tips wrote on June 2011

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Commodity Tips

  • Guest
  • equityinvestorindia wrote on September 2012

Market notices as issues in NSE and BSE by various listed companies in stock market.

  • Guest
  • Mike wrote on April 2013

Good Comparison!

  • Guest
  • aish joshi wrote on June 2013

very nice article it will really helpful for beginners and new traders.

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