Derivatives and advanced market conceptsModule 1, lesson 4 of 21
Call and put options
The right to buy or sell at a fixed price, what call and put buyers and sellers each risk, and why a loss limited to the premium is not low risk.
In this lesson
- Explain a call option and a put option.
- Describe the rights of option buyers and the obligations of option sellers.
- Calculate the result of buying and selling calls and puts at expiry.
- Explain why losing the whole premium is a common outcome for option buyers.
Builds on
- Forwards and futuresOptions are introduced after futures, whose straight-line payoff they modify.
On this page
In simple terms
An option is a contract that gives its buyer a right, but not an obligation, to buy or sell something at a fixed price, called the strike price, on or before a set date.
- A call option is the right to buy at the strike price.
- A put option is the right to sell at the strike price.
The buyer pays the seller a price for this right, called the premium. The seller, or writer, keeps the premium and takes on the obligation to sell (for a call) or buy (for a put) if the buyer exercises.
Calls
Worked example: A made-up call option
Strike ₹1,000; premium ₹30 per share; lot of 500 shares, so the buyer pays ₹15,000.
| Share price at expiry | Call buyer | Call seller |
|---|---|---|
| ₹950 | Does not exercise: −₹15,000 | Keeps premium: +₹15,000 |
| ₹1,000 | −₹15,000 | +₹15,000 |
| ₹1,030 | (30 − 30) × 500 = ₹0 | ₹0 |
| ₹1,100 | (100 − 30) × 500 = +₹35,000 | −₹35,000 |
| ₹1,200 | (200 − 30) × 500 = +₹85,000 | −₹85,000 |
The buyer's loss stops at the premium; the seller's loss keeps growing as the price rises.
Puts
Worked example: A made-up put option
Strike ₹1,000; premium ₹25 per share; lot of 500 shares, so the buyer pays ₹12,500.
| Share price at expiry | Put buyer | Put seller |
|---|---|---|
| ₹1,050 | Does not exercise: −₹12,500 | +₹12,500 |
| ₹975 | (25 − 25) × 500 = ₹0 | ₹0 |
| ₹900 | (100 − 25) × 500 = +₹37,500 | −₹37,500 |
| ₹700 | (300 − 25) × 500 = +₹1,37,500 | −₹1,37,500 |
A put buyer gains when the price falls below the strike by more than the premium. A put seller can lose heavily in a crash.
Rights and obligations
| Buyer (holder) | Seller (writer) | |
|---|---|---|
| Pays or receives | Pays the premium | Receives the premium |
| Has | A right | An obligation |
| Best outcome | Large gain if the price moves far enough | Keeps the premium |
| Worst outcome | Loses the whole premium | Very large loss; margin required |
Limited loss is not low risk
Option buyers are often told that their risk is "limited to the premium". That is true for each trade, but:
- Losing the whole premium is common. Many options expire worthless, a 100% loss on the money spent.
- Repeated small total losses add up. A trader who buys options every week can lose the premium again and again.
- Leverage cuts both ways. A small premium controls a large position, so percentage swings are extreme.
The buyers and sellers lesson compares these risks in detail.
Exercising and closing early
Most option positions are not held to expiry. Buyers and sellers can close a position by trading the option back in the market before expiry, at whatever price it then trades. The result is the difference between the two premiums, not the payoff at expiry shown in the tables above. Closing early can lock in part of a gain or limit a loss, but it depends on finding a buyer or seller at a fair price, as the liquidity lesson explains.
Why it matters
Options appear in news and are widely promoted to individual traders, often with claims about limited risk or steady income. Understanding exactly what each side gains and loses, including the losing side of every example, is the starting point for judging such claims.
Limitations
The examples show results at expiry, ignoring costs, taxes and the possibility of closing before expiry. Exercise style, settlement method, lot sizes and expiries are set by exchange rules and change over time.
Common mistakes
- Believing "limited loss" means low risk.
- Forgetting that sellers' losses can be very large.
- Ignoring the premium when calculating breakeven.
- Mixing up calls and puts.
Try it yourself
- For a made-up call with strike ₹500, premium ₹12 and lot 1,000, calculate the buyer's and seller's results at expiry prices of ₹480, ₹512, ₹550 and ₹600.
- Do the same for a put with strike ₹500 and premium ₹10.
- Note in each case what share of the buyer's money is lost when the option expires worthless.
- Check your answers with the option payoff calculator, switching between buying and selling.
Key takeaways
- A call option gives the buyer the right, but not the obligation, to buy the underlying at the strike price. A put gives the right to sell at the strike price.
- The buyer pays a premium for this right. The seller, also called the writer, receives the premium and takes on the obligation if the buyer exercises.
- An option buyer's loss is limited to the premium, but losing all of it is a common outcome, a 100% loss on the money spent.
- An option seller's gain is limited to the premium, while the possible loss can be very large.
- Options are leveraged. Small moves in the underlying can produce large percentage gains or losses on the premium.
Check your understanding
Try the numbers yourself
- Option payoff calculatorWhere does an option position make or lose money at expiry?
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Terms used in this lesson
- Call option
- A contract giving the buyer the right, but not the obligation, to buy the underlying at the strike price.
- Put option
- A contract giving the buyer the right, but not the obligation, to sell the underlying at the strike price.
- Option premium
- The price paid by an option buyer to the seller, quoted per unit of the underlying.
- Strike price
- The fixed price at which an option's buyer may buy (call) or sell (put) the underlying.
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This lesson is general education, not investment advice. Examples use made-up or clearly dated figures to explain ideas; they are not recommendations. Read the disclaimer.