Understanding Call vs. Put Options: A Guide for Canadian Investors
Discover the key differences between call options vs. put options and learn how to leverage these financial instruments for potential gains in your portfolio.
Updated 
13 min. read
Investing can seem like a complex puzzle, especially in the world of options trading. This guide will walk you through the key differences between call and put options, helping you grasp these essential concepts and make informed decisions.
We have a number of resources including other articles, courses, and webinars to help you understand how call and put options work and the various ways they can be used from conservative strategies designed to reduce risk, to aggressive strategies designed for speculation.
What is Options Trading?
Options trading is a financial investment strategy where you buy and sell contracts that give the contract holder the right, but not the obligation, to buy or sell an underlying asset at a specified price (the “strike price”) within a certain period of time.
This can involve stocks, commodities, or other financial instruments. Here are the key components of options:
- Underlying Asset: The asset you are trading options on, like stocks.
- Strike Price: The price at which you can buy or sell the underlying asset.
- Expiration Date: The date by which you could exercise your option.
- Premium: The cost of purchasing the option.
Options trading offers several advantages, such as the potential for higher returns compared to traditional stock investing and the flexibility to profit from both rising and falling markets. However, it's essential to understand the complexities and risks involved, as mismanagement can lead to significant losses.
The two main types of option contracts are call options and put options, sometimes just referred to as calls and puts. Let’s start with explaining call options.
What is a Call Option?
A call option is a contract that gives you the right, but not the obligation, to buy a specified asset at a predetermined price within a certain timeframe. Here are some key points to understand about call options:
- Right to Buy: You have the right to buy the asset at the strike price before the option expires.
- Profit Potential: If the asset's price rises above the strike price, the call option can become very profitable.
- Bullish Outlook: Call options are typically bought when you expect the asset's price to go up.
- Expiration Date: If the asset's price doesn't rise above the strike price by the expiration date, the option can expire worthless.
Example of a Call Option
Let's consider an example to illustrate how a call option works:
Underlying Stock: Company X’s stock is currently trading at $55 per share on June 1st.
Option Contract Bought: You buy a call option for Company X's stock with a strike price of $60 which expires on June 30th. The option price (premium) is $2.75 per share, so the total cost of the contract is $275 (since options contracts typically cover 100 shares).
Here are a few examples of how the price of the option contract could change depending on Stock X’s share price during the length of the option contract:
| Date | Stock Price | Option Price | Contract Value | Paper Gain/Loss |
|---|---|---|---|---|
| June 1 | $55 | $2.75 | $275 | $0 |
| June 15 | $55 | $7.50 | $750 | $475 |
| Expiry Date | $53 | worthless | $0 | $-275 |
Explanation:
- On June 1, the stock price is $55, which is below the strike price of $60, making the option “out-of-the-money”. The option price is $2.75, making the contract value $275.
- By June 15, the stock price rises to $65, which is above the strike price, making the option “in-the-money”. The option price increases to $7.50, making the contract value $750, with a paper gain of $475.
- By the expiration date, the stock price drops to $53, which is below the strike price, making the option out-of-the-money again. The option is worthless, resulting in a loss of $275.
With option contracts, you can exercise your right if it is profitable to do so, or you can also sell the option contract. Options trade on exchanges just like the underlying stocks do.
In The Money (ITM) vs Out of The Money (OTM)
In options trading, the terms in-the-money (ITM) and out-of-the-money (OTM) describe the intrinsic value of options. A call option is considered in-the-money (ITM) when the current price of the underlying asset is above the strike price. This means that the option has intrinsic value because you can exercise your right to buy the asset at a lower price than its market value.
An option is out-of-the-money (OTM) when it has no intrinsic value. For call options, this is when the underlying asset's price is below the strike price. OTM options are less valuable because they would not be profitable to exercise.
What is a Put Option?
A put option gives you the right, but not the obligation, to sell a specified asset at a predetermined price within a certain period. Here are the key points about put options:
- Right to Sell: You can sell the underlying asset at the strike price before the option expires.
- Profit Potential: If the underlying asset's price falls below the strike price, the put option can be very profitable.
- Bearish Outlook: Put options are typically bought when you expect the underlying asset's price to decline.
- Expiration Date: If the underlying asset's price doesn't fall below the strike price by the expiration date, the option can expire worthless.
A put option is in-the-money (ITM) when the current price of the underlying asset is below the strike price, allowing you to exercise your put option and sell the asset at a higher price than its market value. A put option is out-of-the-money (OTM) when the underlying asset's price is above the strike price.
Example of a Put Option
Here's an example to illustrate how a put option works:
Underlying Stock: Company Y’s stock is currently trading at $90 per share on July 1st.
Option Contract Bought: You buy a put option for Company Y's stock with a strike price of $80 which expires on July 30th. The option price (premium) is $5.00 per share, so the total cost of the contract is $500.
| Date | Stock Price | Option Price | Contract Value | Paper Gain/Loss |
|---|---|---|---|---|
| July 1 | $90 | $5.00 | $500 | $0 |
| July 20 | $75 | $8.00 | $800 | $300 |
| Expiry Date | $95 | worthless | $0 | $-500 |
Explanation:
- On July 1, the stock price is $90, which is above the strike price of $80, making the option out-of-the-money. The option price is $5.00, making the contract value $500.
- By July 20, the stock price drops to $75, which is below the strike price, making the option in-the-money. The option price increases to $8.00, making the contract value $800, with a paper gain of $300.
- By the expiration date, the stock price rises to $95, which is above the strike price, making the option out-of-the-money again. The option is worthless, resulting in a loss of $500.
The Difference Between Call Options and Put Options
Understanding the differences between call and put options is essential for any new investor. Here's a comparison of holding call or put options contracts to help clarify:
| Feature | Call Options | Put Options |
|---|---|---|
Right to | Buy the underlying asset | Sell the underlying asset |
| Profit from | Price increase of the underlying asset | Price decrease of the underlying asset |
| Market Outlook | Bullish (expecting price to rise) | Bearish (expecting price to fall) |
| Profit Potential | Unlimited (as asset price can rise infinitely) | Limited (as asset price can't fall below zero) |
| Premium Paid | Yes, to buy the option | Yes, to buy the option |
How to Buy a Call or Put Option
Here are the basic steps to buy a call or put option:
Step 1: Create an Account
Open an account with a trading platform like BMO InvestorLine Self-Directed.
Step 2: Market Research & Analysis
Analyze market conditions and the current price of the stock. Decide if you are bullish or bearish on the stock in order to determine a possible option strategy to employ.
Step 3: Determine Strike Price and Expiration Date
Decide the price at which you want to reserve the right to buy (call) or sell (put) the asset and the timeframe you want this right (expiration date).
Step 4: Evaluate the Premium
Understand the cost of purchasing the option.
Step 5: Place the Order
Use your trading platform to select the option contract with your desired strike price, expiration date, and premium for the option.
For more detailed steps, check out our Options Trading Product Page
Option Writing Strategies
The world of options trading can be overwhelming, especially when you start exploring advanced strategies like option writing. If you're feeling lost, don't worry! Our Options Trading: Beginner’s Guide is a great place to make sure you understand the basics.
Now that we’ve described being an option contract holder, let’s discuss “writing” option contracts.
What is Option Writing?
While buying option contracts can be profitable, writing option contracts is another strategy that investors can use. When you write an option, you are selling the right to buy (call option) or sell (put option) an asset to another party. Here are the main differences:
Option Holder (What we’ve talked about so far):
- Rights: Buyers have the right, but not the obligation, to exercise the option.
- Profit Potential: Unlimited for calls; limited for puts.
- Premium Paid: Buyers pay a premium to the option writer.
Option Writer:
- Obligations: Writers have the obligation to fulfill the contract if the buyer exercises the option.
- Profit Potential: Limited to the premium received.
- Premium Received: Writers receive a premium from the option buyer.
There are several strategies that involve writing options. One of the most common option strategies used by investors is the Covered Call.
What is a Covered Call?
- Strategy: Writing call options on an asset you already own.
- Objective: Generate additional income from the premium while holding the asset.
- Risk: Limited to the premium received; if the asset's price rises significantly, you might have to sell it at the strike price.
Example of a Covered Call
Let's consider an example to illustrate how a covered call works:
Option Contract Written: You own 100 shares of Company Z, currently priced at $50 per share. You write a call option with a strike price of $55 and an expiry date of August 30th and receive a premium of $2.00 per share, totaling $200.
| Date | Stock Price | Stock Position | Income Received | Paper Gain/Loss |
|---|---|---|---|---|
| August 1 | $50 | +$0 | $200 | $200 |
| August 15 | $53 | +$300 | $200 | $500 |
| August 20 | $60 | +$500 | $200 | $700 |
Note that on August 20th, the stock price went up to $60 and the option holder exercises their right to buy 100 shares of stock Z from you at $55 per share.
Explanation:
- On August 1, you write the call option and receive a premium of $200.
- By August 15, the stock price rises to $53, which is below the strike price, making the option out-of-the-money. The option price decreases to $1.00, making the contract value $100. But you still have the $200 you collected from selling the call option contract and it hasn’t been exercised. Since you own 100 shares of the underlying stock Z, that position has increased in value from $5,000 to $5,300. Right now, you are up $500 overall (the $300 gain on the underlying stock position plus the $200 you made from selling the call option contract).
- On August 20th, the stock price rises to $60, which is above the strike price, making the option in-the-money. The option is exercised, and you are obligated to sell the shares at $55, resulting in a net gain of $700. This is made up of a $500 gain on the underlying shares of stock Z plus the $200 income you initially received from selling this option contract in the first place.
Had you not written a covered call, your stock position would be $6,000 with a paper gain of $1,000. So by writing the covered call, you lost out on a larger potential gain. However, consider what would have happened if stock Z never hit the strike price by the expiry date and the option holder never exercised their right to buy the 100 shares from you. You would have kept the $200 option premium for additional income while the option expired worthless. You also kept your 100 shares of the underlying stock.
Conclusion
Understanding the differences between call and put options, as well as the nuances of option buying and writing, is a foundational step in options trading. By mastering these basics, you can better navigate the investment landscape and make informed decisions.
Ready to start trading? Create an InvestorLine Self-Directed account today and begin your journey into the world of options trading. For more in-depth information, explore our Options Trading 101 Course.
Call vs. Put Option FAQs
Both calls and puts come with their own risks and rewards. Owning call option contracts is generally considered safer in bullish markets, while owning put option contracts is preferable in bearish markets.
Owning calls are generally better in bullish markets, while owning puts are preferable in bearish markets. Writing calls may be preferable in sideways or bearish markets, while writing puts might be preferable in bullish markets.
When writing options, both calls and puts carry significant risks. Writing covered calls may be considered safer because you already own the underlying asset. Writing naked puts, however, can be very risky due to the obligation to buy the asset at the strike price if the market price falls significantly.
Writing naked puts is very risky because you are obligated to buy the asset at the strike price if the option is exercised, regardless of how low the market price drops. This can lead to substantial losses, especially if you do not have the cash or margin to cover the purchase.
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