Calls and Puts Explained: Key Differences, Examples, and How Options Work

Options trading can seem complicated at first, but understanding calls and puts is the best place to start. These two basic types of options contracts allow traders to speculate on price movements, hedge existing investments, and build strategies for different market conditions. The key difference is simple: calls provide the right to buy an asset, while puts provide the right to sell it.

What Are Calls and Puts?

Calls and puts are the two main types of options contracts. An option gives its buyer the right, but not the obligation, to buy or sell an underlying asset at a predetermined price before or on a specified expiration date.

The two types serve different purposes:

• Call option: Gives the buyer the right to purchase an underlying asset at the strike price.
• Put option: Gives the buyer the right to sell an underlying asset at the strike price.

Options are commonly based on stocks, ETFs, indexes, and other financial instruments. Each contract has a strike price, expiration date, and premium, which is the amount the buyer pays to acquire the option.

For standard US equity options, one contract typically represents 100 shares, although adjusted contracts may differ.

What Is a Call Option?

A call option gives its buyer the right to purchase an underlying asset at a specific strike price within the contract's permitted exercise period.

Traders generally buy calls when they expect the underlying asset's price to rise. If the market price moves above the strike price, the call may gain intrinsic value.

Example of buying a call option:

Suppose a stock trades at $100, and you purchase a call option with a $105 strike price. You pay a premium of $3 per share, or $300 for one standard 100-share contract.

If the stock rises to $115 at expiration:

• Stock market price: $115
• Strike price: $105
• Intrinsic value: $10 per share
• Premium paid: $3 per share
• Net profit: $7 per share, or $700 per contract

Your breakeven price at expiration is $108 ($105 strike price + $3 premium).

If the stock remains below $105 at expiration, the option expires worthless, and your maximum loss is the $300 premium paid.

What Is a Put Option?

A put option gives its buyer the right to sell an underlying asset at a predetermined strike price.

Traders typically buy puts when they expect an asset's price to decline. Puts can also help investors protect stock holdings against potential losses.

Example of buying a put option:

Suppose a stock trades at $100, and you buy a put option with a $95 strike price. The premium is $3 per share, meaning you pay $300 for one standard contract.

If the stock falls to $85 at expiration:

• Stock market price: $85
• Strike price: $95
• Intrinsic value: $10 per share
• Premium paid: $3 per share
• Net profit: $7 per share, or $700 per contract

The breakeven price is $92 ($95 strike price − $3 premium).

If the stock stays above $95 at expiration, the put expires worthless, and your maximum loss is the $300 premium.

Calls vs. Puts: Key Differences

Although both calls and puts are options contracts, they serve different trading objectives. Calls are generally associated with bullish expectations, while puts are commonly used for bearish positions or downside protection.

The most important distinction is that buying a call or put gives you a right, not an obligation. Selling either type of option creates an obligation if the contract is assigned.

Buying vs. Selling Calls and Puts

Another important concept is the difference between buying and selling options. Traders can buy or sell both calls and puts, creating four basic positions.

1. Buying a call (Long Call)

A trader buys a call when expecting the underlying asset to increase in value. The maximum loss is the premium paid, while the potential profit is theoretically unlimited as the asset price rises.

2. Selling a call (Short Call)

A trader sells a call to collect the premium, usually expecting the underlying asset to remain below the strike price. An uncovered short call can expose the seller to theoretically unlimited losses if the stock price rises significantly.

3. Buying a put (Long Put)

A trader buys a put when expecting the underlying asset to decline. The position can generate profits as the market price falls below the strike price, after accounting for the premium paid.

4. Selling a put (Short Put)

A trader sells a put to collect premium, typically expecting the underlying asset to stay above the strike price. If assigned, the seller must purchase the underlying asset at the strike price.

These four positions form the foundation of many more advanced options strategies.

What Do ITM, ATM, and OTM Mean?

When comparing calls and puts, traders also need to understand three common terms: in-the-money (ITM), at-the-money (ATM), and out-of-the-money (OTM).

They describe the relationship between an option's strike price and the underlying asset's current market price.

• In-the-money (ITM): A call is ITM when the stock price is above its strike price. A put is ITM when the stock price is below its strike price.
• At-the-money (ATM): The stock price is approximately equal to the strike price.
• Out-of-the-money (OTM): A call is OTM when the stock price is below its strike price. A put is OTM when the stock price is above its strike price.

For example, if a stock trades at $100, a $95 call is ITM, while a $105 call is OTM. For puts, the relationship is reversed.

These classifications help traders evaluate options contracts, but being ITM does not automatically mean a trade is profitable. The premium and transaction costs must also be considered.

How Do Traders Choose Between Calls and Puts?

The choice between calls and puts depends on market expectations, investment objectives, and risk tolerance.

For example, an investor holding 100 shares of a company may purchase a put option to establish a minimum potential selling price. This is commonly known as a protective put.

Meanwhile, a trader who expects a stock to rise significantly might purchase a call rather than buying the shares outright.

However, choosing the correct direction is only part of the decision. Expiration, volatility, and the option premium can all influence the outcome.

What Factors Affect Call and Put Prices?

Option premiums change according to several market factors. Understanding these variables is essential because an option can lose value even when the underlying asset moves in the expected direction.

Underlying asset price: Rising stock prices generally benefit calls and hurt puts. Falling prices generally benefit puts and hurt calls.

Strike price: The relationship between the strike price and market price determines whether an option is ITM, ATM, or OTM.

Time to expiration: Options generally lose time value as expiration approaches. This process is known as time decay.

Implied volatility: Higher implied volatility generally increases both call and put premiums because larger price movements become more anticipated.

Interest rates and dividends: These can also influence option pricing, particularly for longer-dated contracts and stock options.

The Options Industry Council provides additional explanations of option pricing and contract mechanics.

Risks of Trading Calls and Puts

Calls and puts offer flexibility, but options trading carries risks that investors should understand before opening positions.

• Time decay: Purchased options can lose value as expiration approaches, even if the underlying asset does not move significantly.
• Volatility changes: Falling implied volatility can reduce option premiums.
• Leverage: A relatively small premium can control exposure to a larger underlying position, amplifying percentage gains and losses.
• Expiration risk: Options can expire worthless if they finish out-of-the-money.
• Assignment risk: Sellers may be required to fulfill their contractual obligations when assigned.

Buying options generally limits the buyer's loss to the premium paid. Selling uncovered options can create substantially larger losses, including theoretically unlimited losses for uncovered calls.

Before trading, investors should review the SEC's introduction to options and the OCC's Characteristics and Risks of Standardized Options.

Frequently Asked Questions

Is buying calls bullish or bearish?

Buying calls is generally a bullish strategy because the trader expects the underlying asset's price to rise above the strike price enough to cover the premium.

Is buying puts bullish or bearish?

Buying puts is generally bearish because the trader expects the underlying asset's price to decline. Investors also use puts to protect existing stock holdings.

Are calls riskier than puts?

Neither is inherently riskier when comparing purchased options. Both generally have a maximum loss equal to the premium paid. However, selling uncovered calls can create theoretically unlimited losses.

Can you buy calls and puts at the same time?

Yes. Buying a call and a put with the same underlying asset and expiration date is commonly called a long straddle when both have the same strike price. It allows traders to potentially profit from a significant price movement in either direction, although the combined premiums create a substantial cost.

Which is better for beginners, calls or puts?

Neither is automatically better. Beginners should first understand premiums, strike prices, expiration dates, and potential losses. Practicing with a simulated trading account can help build experience before risking real capital.