Call and put options are types of equity options that give their holders, otherwise known as the buyer the right to buy or sell the associated underlying shares of the options. These options are traded on major exchanges like New York Stock Exchange Arca (NYSE Arca) and New York Stock Exchange America (NYSE American), because of this, they are also known as exchange-traded options or listed options.

Generally, these options have a three-paged document known as the Key Investor Document (KID) that indicates the underlying stock, contract terms, and associated risks of the specific option. This information is also made available on the exchange website. We will discuss the call and put options examples using various hypothetical situations of how these equity options work. But before delving into that, let us have a look at the basic terms associated with these stock options.

Basic terms associated with the call and put options

1. At-the-money (ATM)
2. Exercise/exercising
3. Expiration date
4. Fair market value (FMV)
5. In the money (ITM)
6. Option buyer
7. Option seller
8. Out of the money (OTM)
9. Premium
10. Strike price
11. Underlying asset

At-the-money (ATM)

This is a situation whereby the fair market value of the underlying stock associated with an option is equal to its strike price. The option is therefore said to be an at-the-money option. Generally, when an option is at the money, there is no profit to the investor. There might however be a little loss which is the premium paid on the option as well as any other related fees.

Exercise/exercising

When an option buyer exercises their option, it means they have decided to either buy or sell the underlying stocks associated with their option. Investors who have purchased options do not actually own the underlying stocks unless they exercise their option.

Expiration date

This is the stipulated date on or before which an option buyer can exercise their right to either buy or sell the underlying stocks. If the holder of the option does not exercise their right and the option expires, the option seller’s obligation to either sell or buy the underlying shares is no longer valid. The expiration date of the call and put options vary between as short as one week and as long as ten years. Stock options that expire within a given month do so on the expiration Friday. This is usually the third Friday of that given month and the last trading day for the expiring option.

Fair market value (FMV)

The FMV of the underlying stocks is the price at which the stocks will be exchanged between a willing seller and an informed buyer.

In the money

This is when the FMV of the underlying shares is above the strike price of the call option or below the strike price of the put option. When this happens, it results in a gain for the option buyer, and the option is said to be an in-the-money option.

Option buyer

The option buyer is the person who has the right to either buy or sell the underlying stocks of the call or put option. The person is also referred to as the option holder.

Option seller

The option seller is the one who sets the terms of the contract and is also obligated to either sell or buy the underlying stocks of the call or put option. This person is also referred to as the option writer.

Out-of-the-money

This is a situation in which the fair market value of the underlying shares is below the options strike price for a call option or above the strike price for a put option. When this happens, it often results in a loss for the buyer if they exercise the option. Such an option is therefore said to be an out-of-the-money option or underwater.

Premium

The premium is the price that the option buyer pays the option seller when purchasing the call or put option. It is also the price at which the option trades on the exchange, because of this, the option premium fluctuates daily based on the market forces of demand and supply.

Strike price

The strike price of an option is usually preset in the option contract along with the expiration date and other contract terms. It is the price at which the underlying stocks of the call or put option will be bought or sold if the option buyer exercises their option.

Underlying asset

The underlying asset is the stocks that the option buyer has the right to either buy or sell when they exercise their option. For call and put options, each option contains one hundred (100) stocks as its underlying asset.

See also: Different classes of stocks

Call and put options

Call and put options are listed options that can be easily bought or sold in any of the options markets. Generally, the terms of either the call or put option are determined by the option seller and most of these options contain 100 stocks as their underlying shares. These options are regulated by the Securities and Exchange Commission (SEC) and guaranteed by clearing houses such as the Options Clearing Corporation (OCC). The OCC guarantee call and put options transactions so as to minimize the possibility of option sellers failing to meet their obligations of either selling or buying the stocks associated with the options they have sold.

As mentioned earlier, owning options is not the same as owning the underlying stocks. The option buyer will first have to exercise the option before they own the stocks. When it comes to call and put options, their option style is what determines when the option buyer can exercise their option. There are several option styles but the two most popular styles are the American and European options styles.

The American option is one that may be exercised at any time before its stated expiration date. Most exchange-traded options are American-styled options. The European option is one that can only be exercised on its stated expiration date. Most options that are traded over the counter are European-styled options. In this article, the call and put options examples we will discuss hereafter will be based on the American-styled options. Let us now have a look at what call and put options are.

Conversely, the call option seller is obligated to sell the underlying stocks to the option buyer once they exercise their option. While the option buyer’s bet is for a price increase, the option seller’s bet is for a price decrease. The expiration date of call options varies between three (3) months to one (1) year for short-term call options and between three to five years for long-term call options.

The short-term call option is mostly used by investors who looking to boost their income and are willing to take on the risk of betting on the possibility that the underlying stock for which they bought the option will increase within the short time frame of the contract.

The long-term call option is mainly used by investors to plan ahead or speculate. If used for planning ahead, the investor buys the option for stocks that they want to add to their portfolio but do not have the money to buy immediately. Buying the call option for such stocks helps them to buy the shares in the future, within the stipulated period at the strike price even if the fair market value at their time of exercise is above the strike price. If used to speculate, the investor hopes the stock price increases before the options expiry so that they can gain from the option they have purchased.

Both in short-term and long-term call options, the investor’s gain is the difference between its fair market value at the time of exercise and the sum of the premium paid to purchase the option and its strike price. The call option premium is usually priced cheaper than put options. This pricing is based on the likelihood of the option buyer making a profit when they exercise their option. If the fair market value of the stocks increases within the time of the call option contract, the investor gains when they exercise their option. If however, the fair market value does not increase, then the investment becomes either underwater or an at-the-money option.

Additionally, when an investor buys a call option, it is known as a long call option whereas selling a call option is known as a short call option.

Buying call options simplified

As an investor that has purchased a call option, there are three possible outcomes for your options when you exercise them:

1. If the fair market value of the stocks is greater than your options’ strike price, you will make a profit and the call option will be in the money.
2. If the fair market value is equal to your options strike price, you will neither profit nor loss and the call option will be at the money. You have otherwise broken even. Although you will lose the premium and any other fees that you paid on the call option.
3. If the fair market value is less than your options’ strike price, you will incur a loss and the call option will be out of the money.

Selling call options simplified

Just as with the investor, there are three possible outcomes for the option seller when the option buyer decides to exercise their option:

1. If the fair market value of the stocks is greater than the options’ strike price, it will become a loss.
2. If the fair market value is equal to the options’ strike price, the premium paid on the option becomes a profit.
3. If the fair market value is less than the options’ strike price, the difference between the FMV and the strike price as well as the premium becomes a gain.

Pros and cons of call options

Within the table below. we shall outline the pros and cons of call options

Pros	Cons
The premium on call options is usually lower than that of put options	Call options are a risky investment since there is no certainty of the outcome
Option buyers can profit if their prediction turns out right and the fair market value of the shares increases above the strike price.	The option buyer loses if the fair market value of the stocks remains equal to or below the strike price.
Option sellers can profit from the premium paid to purchase the options.	If the fair market value increases above the strike price, the seller loses.

Conversely, the put option seller is obligated to buy the underlying stocks from the option buyer once they exercise their option. While the option buyer’s bet is for a price decrease, the option seller’s bet is for a price increase. If the fair market value of the underlying stocks reduces below the strike price, the put option buyer gets a profit by selling the underlying stocks to the option seller at the higher strike price. Whereas the put option seller loses.

The maximum profit that the option seller gets is limited to the money paid by the option buyer as the put option premium as well as any other related fees. The maximum profit for the put option buyer is the difference between the strike price and the sum of the premium paid and its fair market value at the time of exercise.

Generally, put options are used by investors either to speculate or hedge against a predicted decrease in stock price. Most investors that use put options to speculate do so without actually owning the shares; this is known as buying an uncovered put option. These investors hope to benefit if their speculation turns out right by purchasing the shares at the lesser market price and selling to the put option seller at the higher strike price. Investors that use put as a hedge generally own the stocks for which they purchase the put option, this is known as a covered put option. These investors hope to reduce the loss they will incur when the price of the stocks they own declines.

Additionally, just like call options, there are long and short put options but they differ from that of call options. For put options, when an investor buys a put option, it is known as a short put option whereas selling a put option is known as a long put option.

Buying put options simplified

Investors that have purchased put options whether covered or uncovered have three possible outcomes when they choose to exercise their option.

1. If the fair market value of the underlying stock is higher than the option’s strike price, it results in a loss for the investor. Thus, it is an out-of-the-money option.
2. If the fair market value of the underlying stock is lesser than the option’s strike price, it results in a profit for the investor. Thus, the option is said to be in the money.
3. If the fair market value of the underlying stock is equal to the option’s strike price, it results in a break-even for the investor. This means that the investor has neither gained nor lost and the option is an at-the-money option. However, the premium and other fees will be lost.

Selling put options simplified

1. Put options sellers also have three possible outcomes when an option buyer exercises their right to sell the option’s underlying stocks:
2. If the fair market value of the underlying stock is higher than the option’s strike price, it is considered a profit by the seller.
3. If the fair market value of the underlying stock is below the option’s strike price, it results in a loss.

If the fair market value of the underlying stock is equal to the option’s strike price, it is neither a profit nor a loss. Although the option seller may still profit from the option premium and any other fees charged on the put option’s sale.

Pros and cons of put options

Pros	Cons
Put option sellers can generate an income from the option’s premium and other related fees	The option seller’s losses could be huge especially when the fair market value of the underlying stock declines far below the option’s strike price
Put options are can be an income source, especially for investors who purchase uncovered put options.	Put options are usually more expensive than call options
They can generate a profit for the option buyer and also save as a hedge if the fair market value of the underlying stocks falls below the strike price	Options buyers lose the premium paid and any other related fees if the fair market value of the underlying stock remains equal to or rises above the strike price

Call and put options formulas

Although most investors benefit from exercising their options, some sell back the options to the option sellers. When this happens, the option is said to be closed out. Data from the Chicago Board Options Exchange (CBOE) suggest that about thirty percent (30%) of options are not exercised by their holders, sixty percent (60%) get closed out and only ten percent (10%) are exercised. Investing in call and put options provides benefits to the investors in the form of profits or the return on their investment. This is not always the case however because there are instances where the investors’ prediction does not turn out right and their options expire worthlessly.

Call and put options formulas are generally used to determine if exercising an option is the best way to go or not. For either of these formulas, a result with a minus (-) presents a loss while a positive number could either represent a profit or a breakeven. Let us have a look at the call and put options formula below.

Call option formula

To determine if exercising a call option will make it in-the-money, at-the-money or underwater, the call option formula is very useful. It uses the difference between the fair market value of the stocks and the sum of its premium and strike price. The formula can be expressed as

Call option profit or loss = Current fair market value of stocks – (Premium + Strike price)

Put option formula

The profit or loss incurred by exercising a put option can be determined by calculating the difference between the option’s strike price and the sum of its premium and fair market value. This can be expressed as:

Put options profit or loss = Strike price – (Premium + Current fair market value)

See also: Restricted stocks

Call and put options examples

Now that we have understood what call and put options are, and have seen their formulas. We shall have a look at how these options are used by investors using the various call and put options examples below

Call options examples

Example one

Suppose Elizabeth predicted that the stock price of a solar panel manufacturing company will increase from its current $8 per share price in the near future. If she wants to purchase these stocks but does not have the money to do so right away, she can decide to buy a call option to plan ahead for when she will have the money to purchase these shares.

If Elizabeth buys 2 call options with a strike price of $10, an expiration date of two years, and pays a premium of $25 on each option. If the fair market value of the stocks becomes $12 per stock before the expiration date and she exercises her options, we can calculate her potential profit using:

Call option profit or loss = Current fair market value of stocks – (Premium + Strike price)

Current fair market value of stocks = Fair market value per stock x total number of underlying shares = $12 x 200 = $2,400

Premium = Premium x Number of options = $25 x 2 = $50

Strike price = Strike price x Total number of stocks =$10 x 200 = $2,000

Call option profit or loss = $2,400 – ($50 + $2,000)

Call option profit or loss = $2,400 – $2,050

Call option profit or loss = $350

From the calculation above, we can see that Elizabeth will make a profit of $350 dollars from the two call options she bought. Additionally, she will now own the shares of the solar panel manufacturing company and even though its fair market value had increased from $8 per share to $12, she will still buy the stocks at the lesser $10 dollar strike price. This means that Elizabeth’s call option is in the money.

If however, the stock price decreases instead of increasing, Elizabeth can limit her loss to the premium by not exercising the option.

Example two

Assuming Charles buys a call option for the stocks of a football team and paid a premium of $150 for the option. If the option’s strike price is $35 and the expiration date is one year. For Charles to benefit from the call option, the football team’s stock price will have to increase above the strike price.

Now, let us assume when he bought the call option the stock’s fair market value was $32 per share and then it rises steadily but capped at $35 a few days before the stock expiration date. Typically, this should result in a breakeven where the call option is at the money. However, since he paid a premium and might have paid some other related fees, those could be counted as a loss because whether he chooses to exercise the option or not, he will still lose those. We can calculate the loss he is likely to incur using:

Call option profit or loss = Current fair market value of stocks – (Premium + Strike price)

Current fair market value of stocks = Fair market value per stock x total number of underlying shares = $35 x 100 = $3,500

Premium = $150

Strike price = Strike price x Total number of stocks =$35 x 100 = $3,500

Call option profit or loss = $3,500 – ($150 + $3,500)

Call option profit or loss = $3,500 – $3,650

Call option profit or loss = – $150

Example Three

Suppose Jane bought call options for a conglomerate when its fair market value was $20 with the hope that it will increase in price before her call option expires. If she paid a premium of $100, the option’s strike price and expiration date were set as $22 and 2 years respectively. If the stock price rises to $23 per share before the option’s expiration and she exercises her option, we can determine if she will profit or lose using:

Call option profit or loss = Current fair market value of stocks – (Premium + Strike price)

Current fair market value of stocks = Fair market value per stock x total number of underlying shares = $23 x 100 = $2,300

Premium = $100

Strike price = Strike price x Total number of stocks =$22 x 100 = $2,200

Call option profit or loss = $2,300 – ($100 + $2,200)

Call option profit or loss = $2,300 – $2,300

Call option profit or loss = $0

From the above example, we can see that although there was an increase in the stock price above the strike price, Jane will neither gain nor lose when she decides to exercise her option. Therefore, the option will be considered to be at the money. If however, the increase in stock price resulted in a profit for Jane, the call option could have been in the money.

Put option examples

Example one: covered put option

Assuming Diana owns 500 shares in a robotics company but due to a recent malfunction with one of their products, she feels that the company’s stock price might fall once more people become aware of this. In order to hedge against this perceived reduction in price, she buys 5 put options at a premium of $120 each. If the strike price is $55 and the expiration date is 6 months, assuming the current fair market value of the stock is $60 per share but drops to $45 afterward, we can calculate Diana’s profit or loss using:

Put options profit or loss = Strike price – (Premium + current fair market value)

Strike price = Strike price x Total number of stocks = $55 x 500 = $27,500

Premium = Premium x Number of options = $120 x 5 = $600

Current fair market value = Fair market value per stock x total number of underlying shares = $45 x 500 = $22,500

Put options profit or loss = $27,500 – ($600 + $22,500)

Put options profit or loss = $27,500 – $23,100

Put options profit or loss = $4,400

Since Daina already owns the shares for which she bought these put options, it is a covered put option. She has also been able to successfully hedge against a decline in the robotic company’s stock price. Due to the put options she purchased, she will still be able to sell the shares at $55 per share instead of the lower $45 per share for which it was currently selling at the time of her exercise.

Example two: uncovered put option

Assuming Gregory noticed that people were replacing their gas cookers with electric burners and feel that as a result of this, the stocks of companies that manufacture gas cookers will likely decline in price within the next two years. He then buys 3 put options of one of these companies at a premium of $67 each. If the strike price is $39 and the expiration date is in two years.

Gregory will lose if his prediction does not turn out right and the stock price increases instead of decreasing. But, assuming his prediction turned off right, then he could profit. If the fair market value of the stocks declined from $43 per share to $37 per share, we can calculate his possible profit using:

Put options profit or loss = Strike price – (Premium + current fair market value)

Strike price = Strike price x Total number of stocks = $39 x 300 = $11,700

Premium = Premium x Number of options = $67 x 3 = $201

Current fair market value = Fair market value per stock x total number of underlying shares = $37 x 300 = $11,100

Put options profit or loss = $11,700 – ($201 + $11,100)

Put options profit or loss = $11,700 – $11,301

Put options profit or loss = $399

Now since Gregory does not own these shares, they are an uncovered put option and they are also in the money since the options have resulted in a profit. Gregory can decide to buy the shares at the cheaper $37 per share and sell them to the option seller at the agreed $39 per share. In this way, he has realized an income even though he did not have prior existing shares for the put options he bought.

Example three

Suppose Elias owns one thousand (1,000) shares in a pharmaceutical company whose stock price has been steadily declining. In order to hedge against future decline, he decides to purchase 10 put options to cover the stocks he owns. If the put options cost him $200 each with a strike price of $10 and a two-year expiration period.

However, instead of a decrease in price, the share price of the company increased from $8 to $15 after the company manufactured vaccines for the Covid-19 virus. Using the put option profit and loss formula, we can calculate his potential profit or loss if he were to exercise his option.

Put options profit or loss = Strike price – (Premium + current fair market value)

Strike price = Strike price x Total number of stocks = $10 x 1,000 = $10,000

Premium = Premium x Number of options = $200 x 10 = $2,000

Current fair market value = Fair market value per stock x total number of underlying shares = $15 x 1,000 = $15,000

Put options profit or loss = $10,000 – ($2,000 + $15,000)

Put options profit or loss = $10,000 – $17,000

Put options profit or loss = – $7,000

From the above, we can see that Elias need not exercise his put options since there was a price increase instead of a price decrease. In which case his loss will be the premium $2,000 that he paid to purchase the options and any other related fees. If however for whatever reasons he still exercises the options despite the price increase, he stands the risk of losing $7,000.

Alternatively, assuming the stock price does decline within the stipulated time frame, then Elias would have been able to mitigate the loss that he would have incurred on his underlying 1,000 stocks.

See also: Authorized shares vs Issued shares

Call vs put options

The key thing investors look out for in any investment they make is the potential benefit, otherwise known as the return on investment (ROI) they will get from it. Investors usually buy call options when they believe the price of the underlying stocks will increase and they sell call options when they believe the price will decrease. For put options, investors buy them when they believe the price of the underlying stocks will decrease and sell them when they believe the price will increase. The table below outlines how best to benefit from call and put options.

Price of underlying stocks	Action to take
Expected to rise	Buy call option or sell put option
Expected to reduce	Buy put option or sell call option

Similarities of call and put options

1. Call and put options are both guaranteed by the Options Clearing Corporation (OCC).
2. Both options confer certain rights to their owners.
3. When unexercised, the owners of either call or put options have no access to the underlying stocks.
4. Both calls and puts are traded on the options exchange.
5. Call and put options are both monitored by the Securities and Exchange Commission (SEC).
6. Both options are either long or short options.

Call vs put options differences

Although call and put options share the similarities listed above, there are other features that differentiate them which we shall outline within the table below

Call option	Put option
They give the option buyer the right to buy the underlying stocks.	They give the option buyer the right to sell the underlying stock.
The call option seller is obligated to sell the underlying stocks.	The put option seller is obligated to buy the underlying stocks.
Profitable to the option buyer when the underlying stock price rises above the strike price	Profitable to the option buyer when the underlying stock price reduces below the strike price
The option seller profits when the underlying stock price remains at or reduces below the strike price	The option seller profits when the underlying stock price remains at or rises above the strike price
They are generally uncovered	They can be covered or uncovered

Uses of call and put options

1. Planning ahead
2. Speculating
3. Hedging

Call and put options are useful to investors in three major ways listed above. We shall discuss each of these uses for call and out options below

Planning ahead

Investors who want to purchase stocks such as growth stocks mostly use call options to plan ahead. This is because the investors have speculated that in the near future, these stocks will increase in value and they may not be able to add them to their portfolio when that happens. Therefore, in order to ensure that they will still be able to purchase such shares, they buy call options so that even if the price does increase, they will still be able to purchase the shares at the lower strike price of the call option agreement. Some investors equally use put options to plan ahead, in this case, they mostly sell these options when the market conditions indicate that the underlying stock prices are more likely to increase instead of actually decreasing.

Speculating

1. Buying call option and selling put option
2. Buying a put option and selling a call option

Investors can benefit from an increase in stock price by buying call options and selling put options, they can also benefit from a price decrease by buying put options and selling call options.

Buying call option and selling put option

Investors can benefit from the market movement of the prices of stocks by speculating on how these movements shall be. These can be done by either buying or selling either or both call and put options. If the investor speculates that there might be an upward increase in the price of certain stocks, they can buy call options or sell put options for that particular stock. Now assuming the stock price does increase in price; If they had bought a call option, their potential profit is unlimited since one cannot tell with utmost certainty the level to which the stock price will rise before the options expiration. If they sold a put option, the option buyer is not likely to exercise the option thus the premium paid to them becomes a gain.

On the other hand, if their speculation falls short and instead of an increase in stock price, it decreases instead; For the call option purchase, the investor loss is limited to the premium paid on the call option. If the investor sold a put option, then their potential loss is unlimited as it is determined by the number of underlying stocks and the difference between the current market value of the stocks and the strike price in the option agreement.

Buying a put option and selling a call option

Investors can benefit from a decline in stock price by either buying put options or selling call options or combining both as an investment strategy. When the stock price goes down, investors that have purchased put options will benefit from this to the extent to which the price is reduced below the options strike price.

This is especially true for uncovered put options as the investor can buy the stocks at their current low price and sell them to the option seller at the higher strike price. In the case of selling a call option, the option holder is likely not to exercise their option since it will be underwater. The investor that sold the call option, therefore, benefits from the premium as a profit.

Conversely, if the price decline speculation does not turn out right, and the loss of the investor in buying a put option is limited to the premium paid on the option. For selling a call option, the loss that could be incurred is unlimited as it will be the difference between the option’s strike price and the extent to which the stock price rose.

Hedging

Call and put options can function as effective hedges when they limit the investor’s losses and maximize profits. Hedging through the purchase of call or put options is often practiced by investors who already own these stocks. The investor, therefore, uses the options to hedge their existing equity stocks.

Although these options do not completely erase the possible losses that the investor could likely incur, they serve as a means of reducing the extent to which the losses would have been. They are therefore said to partially compensate the investor for any losses that may be incurred on the underlying stocks.

Investors mostly use these options as a hedge during periods of uncertainty such as an economic downturn. In which case, the buy puts to hedge against a price decline on particular stocks in their portfolio. Investors who have a diversified portfolio often use index puts to hedge against a price decline. Mutual fund managers also use puts to hedge the funds against decline.

See also: Common vs preferred stock

Conclusion

Using call and put options examples, we have been able to see how these options work and how they can either be in-the-money, at-the-money, or out-of-the-money options. These options are typically sold in one hundred (100) units of underlying stocks which are sold at a premium and might attract other payments such as trading fees. The premiums charged on put options are generally higher than that of call options.

Since owners of either call or put options are not obligated to buy or sell the underlying shares, they can decide to either sell off the contract to mitigate various trading expenses that could arise when they want to exercise their option and it is in the money. When the option is underwater, they can decide not to exercise it so as to limit the losses they could incur.

Although option buyers can limit their risk in the aforementioned way, option sellers cannot do the same since they are obligated to either sell or buy the underlying stock once the option they sold gets exercised irrespective of the losses they could incur. However, the sellers could also get the most benefits especially if most of the options they sell expire worthless as they get to keep the premium paid on the options.

Investors should take note of the pros and cons of both call and put options before deciding to either buy or sell either of these options. The call and put options profit or loss formula is also a useful tool that could aid an investor’s decision to either exercise their option or let it expire. Another important thing to note is that when dealing with options, you are mainly speculating about how the underlying stock market prices will go.

Due to this speculative nature of the call and put options, there are no certainties about what the outcome of your investment will be. Hence it is best to consult a professional before choosing either of these investments. Investors should also ensure they read through the three-paged document Key Investor Document (KID) so as to familiarize themselves with the underlying stock, contract terms, and associated risks of the call or put option they are purchasing.

Call and put options examples