When thinking about different investment options, it is key to understand the difference between call options and put options. While they are both derivatives, meaning that their price movements are based on the price movements of other financial products, there are some key differences. This is why we've compiled this short guide on call and put options.
Firstly, it is key to define what we mean by the term “option.” Put simply, options describe contracts giving buyers the right to buy or sell an underlying asset or security at a specific price and by a specific date. This specific price is called 'strike price'.
Put options - definition
If traders expect the stock price of an underlying asset to decrease within a specified time, investors will tend to buy what is called put options. The strike price in put options refers to the price at which traders can sell the underlying asset. For example, buyers of a stock put option with the option's strike price of GPB 150 can use their option to sell the stock for GPB 150 before the expiration date. For the right to sell the stock at the strike price for a given period, the buyers will have to pay a premium. This premium goes to the put seller, which is why writing put options can be an effective means of generating income. If you want to identify the cost of the put option, multiply the underlying share price by a factor of 100 (as put options represent 100 shares of the underlying stock).
Call options - definition
If traders expect the stock price of an underlying asset to increase within a specified time, traders will buy what is termed call options. The strike price for call options is the predetermined price the buyer can purchase the underlying asset for. So having purchased a stock call option with a strike price of GPB 150, you could as a trader then use the option to buy the stock at GPB 150 within the defined timeframe. However, unless the current price of the underlying asset is below the strike price, this option is not worth it (it would be more lucrative to buy the asset on the market). Buyers of the call option also have to pay a premium for the right to purchase at the strike price. If you want to calculate the call option, multiply the cost of the contract by 100 (as one call option represents 100 shares of the underlying stock).
What's the difference?
Call and out options are very different trading methods. If you are risk-averse, options can be a viable strategy. However, call and put options will always have an element of risk.