When should you buy put option and call option?

Answer 1

In commercial contracts, there are situations of defaults/deadlock between the parties. In such a situation parties are given options, like put and call options as exit strategy. A call option is a mechanism wherein a party can call the another party to do something. Such kind of arrangements can specially be seen in shareholders/joint venture agreement where in case of default first party can ask the second party to sell its shares to first party.

Answer 2

Futures Contract:

A futures contract is an agreement to buy or sell an asset at a certain time in the future at a specific price. The Contractual terms of the futures contracts are very clear. The Futures market was designed to solve the shortcomings in the forwards contracts. Unlike forwards, futures are traded in organized exchanges. They also use a clearing house that provides the necessary protection to both the buyer and the seller. The price of the futures contract can change prior to delivery. Hence, both participants must settle daily price changes as per the contract values.

An Example of a futures contract would be an agreement to 100 tonnes of Steel at Rs. 10000/- per tonne at some date say in December 2008. If no interim payments are made and if the price of Steel moves violently, a considerable credit risk could build up. To avoid this a margin system is used by the exchanges. As per the margin system, both parties must deposit a small sum with the exchange. This amount will be a small percentage of the total contract. This amount is called the initial margin. As the steel value changes, the contract value also changes. If the contract value changes, the margin must be topped up by an amount corresponding to the change in price of steel. The margin money is the property of the person who deposits it and would be returned to them if the contract gets cancelled/completed.

Characteristics of Futures contract:

1. They are traded in organized exchanges

2. Credit risk is eliminated with the margin system. Both parties deposit a portion of the contract with the clearing house.

3. Both the buyer and seller are bound by the contract terms and are expected to honour their end of the contract.

Options Contract:

An options contract is nothing but the right to buy or sell something at a specified price within a period of time. The feature of the options contract for a buyer is that, the buyer has the right to buy, but he may choose to buy or may even choose to cancel the contract. Hence the buyers maximum loss is only the initial amount that was paid to gain the rights. Unlike buyers, the options contracts for sellers is an obligation. If a seller enters into an agreement, he has to deliver the asset on the specified date and the price agreed upon. Thus the loss for a seller could be much worse.

The right to buy is called a "CALL" option while the right to sell is called a "PUT" option. Please note that an option is only a right to do something. It is not an obligation to carry out the action. For a buyer it is only a right and not an obligation, but for a seller it is an obligation.

For Example, you want to buy Gold. You form an options contract with a Gold merchant to buy 1000 grams of Gold at the rate of say Rs. 1000/- per gram of gold on December 1st 2008. The total value of the contract would sum up to 10,00,000/- (10 lacs) As part of getting into the contract you make an initial payment of say 2% of the contract value to the merchant. You make a payment of Rs. 20 thousand (Rs. 20,000/-) and the contract gets formed. Now you are the buyer and the merchant is the seller.

Now there could two possible scenarios:

1. Assuming on 1st December the price of gold is Rs. 1050/- per gram, then to buy thousand grams of gold you would need Rs. 10,50,000/- rupees which is Rs. 50,000/- more than your options contract. Hence if you exercise your right to buy, you stand to make a profit of Rs. 50,000/- At the same time, the seller has an obligation since he has agreed on the contract and he has to sell the gold to you at a loss of Rs. 50,000/- when compared to the market rate.

2. Assuming on 1st December the price of gold is Rs. 950/- per gram, then to buy thousand grams of gold you would need Rs. 9,50,000/- which is Rs. 50,000/- less than your options contract. Hence if you exercise your right to buy, you stand to lose Rs. 50,000/- You can buy the same quantity of gold in the market at a lesser price. Hence you can choose to let your contract expire and limit your losses to only Rs. 20,000/- The Seller on the other hand does not make any transaction but still stands to keep the Rs. 20,000/- you paid him to form the contract.

This 1000 rupees per gram that you agreed upon with the merchant is called the "Strike" Price.

The initial deposit of Rs. 20,000/- you paid him is called the "Option premium".

Partcipants in an Options market:

1. Buyers of Calls

2. Sellers of Calls

3. Buyers of Puts

4. Sellers of Puts

People who buy options are called "Holders" and those who sell options are called "Writers"

Call Holders and Put Holders (The Buyers) are not obligated to buy or sell. They have the right to do so if they wish. Similarly Call writers and Put Writers (The Sellers) are obliged to buy or sell. This means that they need to buy or sell if the Call holder decides to exercise his right to buy.

Answer 3

To every buyer in Stock Market , there is a seller. So lets break this into 2 parts

1. Advantages for buying put and call options - Option buying means setting limited loss and unlimited profit. For example - if currently index is 1000 and you have bought 1100 call @ $34, your profit will be unlimited over and above 1100 but your loss is limted i.e $34 if it expires the series below 1100. So you pay a premium of $34 to buy the call. Buying calls and puts are beneficial if you anticipate sharp move in either direction.

2. Advantage of selling put and call options - Option selling means setting unlimited loss and limited profit. For example - if currently index is 1000 and you have sold 1100 call @ $34, your loss will be unlimited over and above 1100 but your profit is limted i.e $34 if it expires the series below 1100. So you get a premium of $34 to sell the call. Selling calls and puts are beneficial if you expect a range bound move so that you can eat away premium due to time decay.

Answer 4

Call options are contracts that allows you to buy a stock at a fixed price no matter what price it is in the future. You usually buy call options if you think a stock is going to go up because you will still be able to buy the stock at a fixed lower price.

Put options are contracts that allows you to SELL a stock at a fixed price no matter what price it is in the future. You usually buy put options if you think a stock is going to go down because you will still be able to sell the stock at a fixed higher price.

Answer 5

These are mainly used in forex marketing. They are essentially buy or sell contracts. In binary options these contracts indicate whether a person who entered the contract thinks the price will go up or down in a certain period of time.

Answer 6

A call option is an agreement between two individuals or entities to buy or sell a product. A put option is very similar to a call option. The difference is that there is a specific date associated with the sale or resale of the item.

Answer 7

Stock options give the right, but not the requirement, to buy or sell shares at a certain price on a certain date. A put option gives its buyer the right to sell, or put, a stock to the put seller. A call option gives its buyer the right to buy, or call, a stock. These are sold in 100-share lots. There are three numbers you need to deal with here: stock price, strike price and premium. The premium's the amount you pay to buy an option. Say it's a dollar a share, although it can be anything and there are a lot of factors that go into setting the premium. Anyone can understand the stock price. The strike price is what the stock price needs to be either above (if you're dealing in calls) or below (for puts) before the option should be exercised. If you're buying puts and you have one with a strike price of $10 per share, if the stock price is above that you won't exercise the option because someone else will buy it from you for more money.

There are two kinds of options: covered and naked. A covered option is one where the person who is going to sell the stock owns it already; a naked option is where you don't own it. You've got three days after the option is exercised to deliver the shares, so if you bought a naked put on 1000 shares for $10 per share strike price and the share price drops to $9, you exercise the put, get the $10,000--the money transfers into your brokerage account immediately--spend $9000 buying the stock, deliver it and keep the change. There are naked calls too, and if one of those is exercised on you you'll have to pull the extra money out of your pocket. (Naked calls are close to casino gambling in that you are betting the option won't exercise.)

Answer 8

A call option gives its buyer the right, but not the obligation, to purchase (or "call in," which is where the name comes from) something from the person who sold him the option at a specified price.

A put option gives its buyer the right, but not the obligation, to sell (or put in the other person's hands) something to the person who sold him the option, once again at a specified price.

In both cases, the person buying the option has to pay money, which is called a premium.

Let's look at this from the buyer's standpoint. You trade stocks to make money. If you think a stock is going to go up a lot, you can buy a call. If the stock price exceeds the price on the call (aka "strike price") you exercise the call--you buy the stock from the call's seller--then sell the stock on the open market and pocket the difference.

On the other hand, if you think a stock is going to go down in price, you buy a put. (A good investment strategy here is to buy a "naked put"--one where you don't own the stock you're writing against yet.) If the stock DOES go down in price, you exercise the put. The money for the stock will wind up in your trading account. You've got 72 hours from that point to buy enough stock to fulfill the contract if you don't already have it, so you take the money you were paid--you get that right away--have your broker get you the stock you need, turn it over to the put seller and pocket the profit.

Both these options have expiration dates. If a put expires with the stock priced above the strike price or a call expires with the stock priced below the strike price, the option "expires worthless." If you bought a put at $20 and the stock trades at $25 on the expiration date, you'd be really dumb to go through with the trade...so no one does it.

Answer 9

You buy put options when you expect the stock to go DOWN.

You buy call options when you expect the stock to go UP.