How Call and Put Options Work in India? – What are Stock Options?

Today’s article will discuss: How Call and Put Options Work in India? Before that, we will understand what it is with an example of the same.

Call and Put Options in Stock Market

Stock options are a type of financial contract between a buyer and seller that give the holder the right, but not the obligation, to buy or sell a stock at a predetermined price (strike price) on or before a specified date (expiration date).
These options can be used for a variety of purposes, including as a form of compensation for employees or as a way to hedge against market fluctuations.

When a stock option is granted, the option holder has the right to buy or sell the underlying stock at the strike price, regardless of the market price of the stock at the time of exercise.
This allows the option holder to potentially profit from favorable market movements, or to protect against unfavorable movements.

The value of a stock option is derived from the underlying stock, and is influenced by several factors including the current market price of the stock, the strike price, the expiration date, and the volatility of the stock.
The option’s intrinsic value is equal to the difference between the market price and the strike price, while its extrinsic value is made up of the time value and volatility.

Stock options can also be used to incentivize employees by linking their compensation to the performance of the company’s stock.
This can help align the interests of employees with those of the company and its shareholders.

Overall, stock options are a flexible and powerful tool for managing risk and leveraging market movements, but it is important to understand their complexities and potential consequences before entering into such contracts. Now let’s discuss how Call and Put Options work.

How Call and Put Options Work?

Call and Put options are two types of stock options in India. They work as follows:

Call Options:

• A call option gives the buyer the right, but not the obligation, to buy a stock at a specified price (strike price) on or before a specified date (expiration date).
• If the stock price rises above the strike price, the buyer can exercise the option to buy the stock at the lower strike price and sell it at the higher market price, making a profit.
• If the stock price remains below the strike price, the option will expire worthless, and the buyer will not exercise it.

Put Options:

• A put option gives the buyer the right, but not the obligation, to sell a stock at a specified price (strike price) on or before a specified date (expiration date).
• If the stock price decreases below the strike price, the buyer can exercise the option to sell the stock at the higher strike price, avoiding a potential loss.
• If the stock price remains above the strike price, the option will expire worthless, and the buyer will not exercise it.

However, It's important to note that there are also risks involved when trading call and put options, including the possibility of losing the entire premium paid for the option, and a thorough understanding of the stock market and options is recommended before entering into such contracts.

Example

For instance, Let's say John works for an Indian tech company and is granted stock options as part of his compensation package.
The company offers him the option to buy 1,000 shares of company stock at a strike price of ₹3,000 per share, with an expiration date of two years from now.

Fast forward one year, and the company's stock price has increased to ₹4,200 per share.
John decides to exercise his option to buy the 1,000 shares at the strike price of ₹3,000.
He can then sell the shares for ₹4,200 each, making a profit of ₹1,200 per share, or ₹1.2 million in total.

However, if the company's stock price had decreased to ₹2,400 per share, John may choose not to exercise his option and avoid a loss.

This example illustrates how stock options can allow individuals to potentially profit from favorable market movements or protect against unfavorable ones.
However, it is important to note that there are also risks involved, and a thorough understanding of the stock market and stock options is recommended before entering into such contracts.

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