In options trading, two terms that are commonly used are “CE” and “PE.” These are Call Option and Put Option, respectively. In this blog post, we will discuss the basics of CE and PE, how they work in options trading, and how to use them effectively in your trading strategy.
What is CE
CE stands for Call Option, which gives the holder the right, but not the obligation, to buy an underlying asset at a predetermined price, known as the strike price, within a specified period. A Call Option is bought when the investor expects the price of the underlying asset to rise in the future.
For example, the current market price of a stock is Rs 500. You believe that the stock price will increase in the next few weeks. You can buy a Call Option with a strike price of Rs 550 for a premium of Rs 20.
If the stock price rises above Rs 550 before the expiration of the option, the investor can exercise the option and buy the stock at Rs 550, making a profit of Rs 10 per share (current market price of Rs 580 minus the strike price of Rs 550 and the premium paid of Rs 20).
How to Use CE in Options Trading
When to buy CE: A Call Option should be bought when the investor expects the price of the underlying asset to rise in the future. Buying a Call Option is a bullish strategy. The investor can profit if the price of the underlying asset rises above the strike price.
When to sell CE: A Call Option can also be sold if the investor expects the price of the underlying asset to remain stagnant or fall in the future. Selling a Call Option is a bearish strategy. The seller collects the premium on the option. The investor can profit if the price of the underlying asset remains below the strike price. Maximum profit can be upto the premium collected.
For example, the current market price of ABC stock is Rs 500 per share, and you decide to sell a Call Option with a strike price of Rs 550 for a premium of Rs 20 per share.
If the price of ABC stock remains below Rs 550 until the option expiration date, the option will expire worthless, and you get to keep the Rs 20 per share premium as a profit.
If the price of ABC stock rises above Rs 550, the buyer may decide to exercise the option, and you will have to buy the shares at market price and sell to the option buyer at Rs 550 per share. Your loss will be Rs 20 (stock market price 590 – 550 strick price – 20 premium collected).
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What is PE
PE stands for Put Option, which gives the holder the right, but not the obligation, to sell an underlying asset at a predetermined price, known as the strike price, within a specified period. A Put Option is bought when the investor expects the price of the underlying asset to fall in the future.
For example, let’s say that the current market price of a stock is Rs 500. An investor believes that the stock price will decrease in the next few weeks. The investor can buy a Put Option with a strike price of Rs 450 for a premium of Rs 20.
If the stock price falls below Rs 450 before the expiration of the option, the investor can exercise the option and sell the stock at Rs 450, making a profit of Rs 30 per share (strike price of Rs 450 minus the current market price of Rs 400 and the premium paid of Rs 20).
How to Use PE in Options Trading
When to buy PE: A Put Option should be bought when the investor expects the price of the underlying asset to fall in the future. Buying a Put Option is a bearish strategy. The investor can profit if the price of the underlying asset falls below the strike price.
When to sell PE: A Put Option can also be sold if the investor expects the price of the underlying asset to remain stagnant or rise in the future. Selling a Put Option is a bullish strategy. The investor can profit if the price of the underlying asset remains above the strike price.
For example, the current market price of XYZ stock is Rs 750 per share, and you decide to sell a Put Option with a strike price of Rs 700 for a premium of Rs 10 per share.
If the price of XYZ stock remains above Rs 700 until the option expiration date, the option will expire worthless, and you get to keep the Rs 10 per share premium as profit. If the price of XYZ stock drops below Rs 70, you will have to buy shares at Rs 700 per share.
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How to Use CE and PE for Hedge
Hedging is a risk management strategy that involves using one investment to offset the risk of another investment. CE and PE can be used for hedging to reduce the risk of losses in a portfolio.
For example, if an investor holds a stock portfolio and expects the market to fall, the investor can buy a Put Option to protect against potential losses. Similarly, if an investor holds a short position in a stock and expects the market to rise, the investor can buy a Call Option to protect against potential losses.
How to Use PE for Hedging
To hedge against potential losses in a stock portfolio, an investor can buy a Put Option with a strike price close to the current market price of the stock. If the stock price falls, the Put Option will increase in value, offsetting the potential losses in the portfolio.
For example, you own a portfolio of stocks worth Rs 100,000 and you have a bearish view. You purchase 10 Put Options on a stock index that tracks the overall market, with a strike price of Rs 10,000 and a premium of Rs 500 per option.
If the value of the stock index falls to Rs 9,500, the Put Options will increase in value by Rs 500 per option, resulting in a total profit of Rs 5,000 (Rs 500 x 10) that can be used to offset the losses in your portfolio. If the value of the stock index remains above Rs 10,000, the Put Options will expire worthless, and you will only lose the premium paid for the options.
How to Use CE for Hedging
To hedge against potential losses in a short position, an investor can buy a Call Option with a strike price close to the current market price of the stock. If the stock price rises, the Call Option will increase in value, offsetting the potential losses in the short position.
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FAQs
Q1. How do I buy CE or PE?
To buy a Call Option (CE) or Put Option (PE), you need to have a trading account with a broker that offers options trading. You can place an order to buy CE or PE by specifying the underlying asset, strike price, expiration date, and premium.
Q2. Can I sell CE or PE?
Yes, you can sell a Call Option (CE) or Put Option (PE) in options trading. When you sell an option, you receive a premium, and you are obligated to sell (in the case of CE) or buy (in the case of PE) the underlying asset at the specified strike price if the buyer decides to exercise the option before expiration.
Q3. What happens if my CE or PE expires worthless?
If your Call Option or Put Option expires worthless, you will lose the premium paid to buy the option. If you sell the call or put option, then you will keep the premium as your profit.
Q4. What is the margin requirement for trading CE and PE?
The margin requirement for trading Call Options and Put Options varies depending on the broker and the underlying asset. You will need to have sufficient funds in your account to cover the margin requirement.
Q5. What is the strike price?
The strike price is the price at which the holder of the option can buy or sell the underlying asset. It is an important parameter in options trading because it determines the profit or loss of the option holder. The strike price is set at the time the option is created and remains fixed throughout the life of the option.
Q6. How do I calculate profits and losses with CE and PE?
To calculate the profits and losses with Call Options (CE) and Put Options (PE), you need to consider the premium paid or received, the strike price, and the price of the underlying asset at the expiration date. If the price of the underlying asset is higher than the strike price in the case of CE or lower than the strike price in the case of PE, you make a profit. Otherwise, you incur a loss.
Q7. What factors affect the value of CE and PE?
The value of Call Options (CE) and Put Options (PE) is influenced by various factors, including the price of the underlying asset, time to expiration, volatility, interest rates, and dividends.
Q8. What is the premium in options trading?
In options trading, the premium is the price that an investor pays for buying an options contract. An options contract gives the buyer the right, but not the obligation, to buy or sell an underlying asset (such as a stock or commodity) at a specified price and within a specified time frame.
Conclusion
Call Options and Put Options are powerful financial instruments that can be used to manage risk and generate profits in options trading. Both CE and PE can be used for hedging to reduce the risk of losses in a portfolio.
Understanding the strike price, calculating profits and losses, and knowing the factors that affect the value of CE and PE are essential for successful options trading.
If you are interested in options trading, take the time to learn more about CE and PE and start exploring them in your own trading strategies.
