the call vs put maze simplified
in 2002, Warren Buffett had called them financial weapons of mass destruction, terming them ‘dangerous’. the derivatives market, however, continues to stay popular among stock market investors. derivatives are forms of financial contracts. their value depends on the price of the asset being traded.
there are various forms of derivatives, in which options are the most popular ones. options per se do not have any value but derive their value from underlying assets like shares. simply put, they are an agreement between two parties to buy or sell an asset at a predetermined date and price. the buyer can also cancel the existing agreement within this date.
call and put are the two types of options available. call refers to locking the share price in anticipation of a price rise, while put is locking the price in anticipation of a fall.
let’s say an investor named Sarah wants to buy shares of Reliance Industries, which are trading at Rs 2,500. but Sarah knows the prices will go up soon. so she can exercise the call option for Rs 2,600 for a date. this is possible because the call option allows her to lock the share price at a fixed amount and buy it within a particular date.
if the stock price crosses Rs 2,600 by that date, she can use the call option and buy it at Rs 2,600. a call option is helpful when there’s a likelihood of stock price increasing. a premium/commission is to be paid for this.
on the other hand, if there is an expectation that Reliance Industries’ share will fall, Sarah can exercise the put option. it allows her to lock the share price at a fixed amount and sell it within a particular date. say the put option price of the Reliance Industries shares is set at Rs 2,200, then the stock can be sold as soon as this fall occurs. again, a commission is charged.
in a volatile market, when stock prices are fluctuating too often, the call and put options help mitigate the equity risks and minimize losses. the advantage of call and put is that there is no obligation for the investor to undertake the transaction. this means that if the contract is canceled before the expiry date, they lose just the commission amount.
for new entrants to the equity markets, timing is crucial. so it is essential to study the fundamentals of any stock and what affects its price before opting for a call or put.