2025-09-23
Call and put options are financial contracts that give traders the right, but not the obligation, to buy or sell an asset at a set price within a specific period.
Calls grant the right to buy, while puts grant the right to sell, making them powerful tools for speculation, hedging, and income generation.
Because options can be used in both rising and falling markets, they have become essential instruments for traders seeking flexibility and risk control.
Below, we will break down what calls and puts are, explain how they work, explore their profit and loss profiles, highlight common strategies, outline key risks, and answer frequently asked questions.
Options are financial contracts that give traders flexibility unmatched by most other instruments. Unlike buying shares outright, where you must commit a large amount of capital, options allow you to control an asset for a fraction of the cost.
There are three main reasons traders turn to options:
Speculation: betting on the direction of a market without owning the asset.
Hedging: protecting existing investments against losses, much like buying insurance.
Income generation: selling options to collect premiums, often as part of a structured strategy.
In each of these uses, the basic building blocks are the same: the call and the put.
Since calls and puts are central to options trading, a preliminary step is to clarify the terminology that governs this market.
1) Underlying Asset:
The stock, index, or commodity on which the option is based. For example, a call option on Apple shares gives rights linked to those shares.
2) Strike Price:
The fixed price at which the underlying asset can be bought or sold through the option.
3) Expiration Date:
The date on which the option contract ceases to exist.
4) Premium:
The cost of the option, paid by the buyer to the seller. This is the maximum risk for a buyer.
5) In-the-Money, At-the-Money, Out-of-the-Money:
These are the terms describing whether the option has intrinsic value at the current market price.
With these definitions in place, we can now explore the two types of option contracts.
A call option gives the holder the right, but not the obligation, to buy the underlying asset at the strike price on or before the expiration date.
Who uses calls?
Traders who expect the price of an asset to rise often buy calls.
This allows them to profit from the increase without having to buy the full number of shares outright.
Calls are also used by investors who want to lock in a purchase price for future acquisitions.
Profit and loss profile
For the buyer, the maximum loss is the premium paid. The potential profit, however, is theoretically unlimited as the price of the underlying asset rises.
For the seller (also known as the writer), the opposite is true: they receive the premium upfront, but face potentially unlimited losses if the asset's price climbs sharply.
Practical example
Suppose you buy a call option for Company A with a strike price of £100. paying a £5 premium.
If the share price rises to £120 before expiration, your option is worth £20 (the difference between the strike and the market price), minus the £5 premium, giving a £15 profit per share.
A put option gives the holder the right, but not the obligation, to sell the underlying asset at the strike price on or before the expiration date.
Who uses puts?
Traders buy puts when they expect the market to fall.
Investors who already own shares may buy puts as insurance against a downturn, protecting themselves if the stock price collapses.
Profit and loss profile
For the buyer, losses are capped at the premium paid. Gains can be significant if the underlying asset falls well below the strike price.
For the seller, the premium received is the maximum gain, but losses can be large if the asset's value declines.
Practical example
You own shares in Company B, currently worth £50. You buy a put with a strike price of £48 for a £2 premium.
If the share price falls to £40. you can still sell at £48. effectively limiting your loss. The cost of this protection was the £2 premium.
| Feature | Call Option | Put Option |
| Right conferred | Right to buy | Right to sell |
| Market outlook | Bullish (expecting a rise) | Bearish (expecting a fall) |
| Buyer's maximum loss | Premium paid | Premium paid |
| Buyer's maximum gain | Unlimited (in theory) | Significant (to zero price of asset) |
Once you understand calls and puts individually, you can combine them into more advanced strategies:
Covered Calls – owning a stock and selling calls against it to generate extra income.
Protective Puts – holding a stock and buying a put to limit potential losses.
Spreads – buying and selling options at different strike prices or expirations to shape risk and reward.
The Role of Time and Volatility – option prices are influenced by time decay (the closer to expiry, the lower the option's time value) and implied volatility (expectations of future price swings).
These strategies show how calls and puts can be more than simple bets on direction – they can be tools for precise risk management.
Options offer opportunity but also come with significant risks.
Buyers risk losing the entire premium if the option expires worthless.
Time decay steadily reduces an option's value if the underlying asset does not move favourably.
Sellers can face unlimited losses if they are not covered by owning the underlying asset.
Liquidity and transaction costs can also erode profits.
Careful planning and discipline are essential for any trader using options.
1) A Winning Call
An investor buys a call option on a stock at £100 with a £5 premium. The stock rises to £120. The option is worth £20. and after the £5 premium, the profit is £15 per share.
2) A Losing Put
A trader buys a put with a strike price of £50 for £3. The stock stays at £52 until expiry. The option expires worthless, and the £3 premium is lost.
3) Expires Worthless Scenario
Many options expire without value. This is not unusual and simply means the buyer loses the premium, while the seller keeps it as profit.
These examples highlight both the potential and the risks of trading options.
At their core, calls give you the right to buy, and puts give you the right to sell. Both can be used in isolation, but their true power comes when combined into broader strategies.
Mastering these two instruments gives traders the flexibility to adapt to rising, falling, or even sideways markets.
1. What happens if my option expires out-of-the-money?
It becomes worthless. As the buyer, you lose the premium paid. As the seller, you keep the premium as profit.
2. What's the difference between American and European options?
American options can be exercised at any time before expiration. European options can only be exercised at expiration.
3. How are option prices determined?
Option pricing is based on several factors, including the underlying asset's price, strike price, time to expiration, volatility, interest rates, and dividends. The price consists of intrinsic value plus time value.
4. Can beginners trade options safely?
Yes, but only if they start with basic strategies, risk small amounts, and understand that options can expire worthless. Simple approaches like protective puts or covered calls are suitable starting points.
Disclaimer: This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by EBC or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.
