CE and PE in Stock Market : Understanding CE (Call Option) and PE (Put Option) is crucial for navigating the stock market. CE grants investors the right to buy a specific asset (like stocks) at a predetermined price, while PE gives the right to sell. These options provide opportunities to leverage positions and capitalize on market movements. CE holders anticipate rising prices above the strike price, exercising the option “in the money.” Conversely, PE holders anticipate falling prices below the strike price to profit. Both options involve a premium paid to the option seller and can be utilized for various investment strategies.
Table of Contents
What is CE in Stock Market?
A call option is a contract that gives investors the right to buy a specific quantity of stocks at a set price (strike price) within a certain timeframe (expiration date). The buyer pays a premium to the seller for this privilege. With a call option, investors expect the stock price to go up above the strike price. If it does, they can exercise the option and buy the stocks at the predetermined price. However, if the stock price stays below the strike price or falls further, the call option expires worthless, resulting in a loss of the premium paid.
What is PE in Stock market ?
A put option is a contract that gives investors the right to sell a specific quantity of stocks at a predetermined price (strike price) before the expiration date. Like call options, put options involve a premium paid by the buyer to the seller. Investors who purchase put options anticipate the stock price to decrease below the strike price. If it does, they can exercise the option and sell the stocks at the predetermined price. On the other hand, if the stock price remains above the strike price or rises further, the put option expires worthless, resulting in a loss of the premium paid.
Using Call and Put Options
Now that you are familiar with what CE and PE in stock market is, lets learn how to use them in trading. Call and put options provide investors and traders with opportunities to take advantage of both rising and falling markets. They are commonly utilized for trading and investment strategies, such as hedging, speculation, and income generation. It’s important to note that options trading carries risks, including the potential loss of the entire premium paid. Therefore, it’s crucial for investors to thoroughly understand the mechanics, risks, and potential rewards associated with options before engaging in trading activities. Seeking guidance from a financial advisor and conducting comprehensive research is highly recommended before entering the world of options trading.
How to use Call and Put Options for Hedging
CE and PE in stock market can be used to reduce risk on stock investments. This is called as hedging. Hedging is a risk management strategy used by investors to protect against potential losses in the stock market. Call options (CE) and put options (PE) can be employed as hedging tools to mitigate risks. Let’s explore how to hedge using these options:
Hedging with Call Options (CE)
To hedge against potential losses in a stock position, you can purchase call options. Here’s how it works:
- Identify the stock you want to hedge: Determine the stock position that you want to protect from potential downside risk.
- Assess the number of call options needed: Calculate the number of call options required to offset the stock position. Each call option typically covers a specific quantity of underlying stocks.
- Buy call options: Purchase call options with a strike price and expiration date that align with your hedging strategy. If the stock price falls, the value of the call option should increase, offsetting the losses in the stock position.
Monitor and adjust: Keep a close eye on the market and your hedged position. If the stock price rises and your concerns diminish, you can choose to sell the call options or let them expire.
Hedging with Put Options (PE)
To hedge against potential losses in a stock position, you can also utilize put options. Here’s how to hedge using put options:
- Identify the stock you want to hedge: Determine the stock position that you want to protect from potential downside risk.
- Assess the number of put options needed: Calculate the number of put options required to offset the stock position. Each put option typically covers a specific quantity of underlying stocks.
- Purchase put options: Acquire put options with a strike price and expiration date that align with your hedging strategy. If the stock price declines, the value of the put option should increase, offsetting the losses in the stock position.
- Monitor and adjust: Continuously monitor the market and your hedged position. If the stock price starts to rise, you may choose to sell the put options or allow them to expire
Important things to consider while hedging
- Cost: Keep in mind that purchasing call or put options involves paying a premium, which adds to the overall cost of your hedging strategy.
- Hedging period: Determine the duration for which you want to hedge your position. Make sure the expiration dates of your options align with your hedging timeframe.
- Risk tolerance: Assess your risk tolerance and financial goals before implementing a hedging strategy. Hedging can limit potential losses but may also limit potential gains.
Important terminologies while trading in options
ATM, OTM, and ITM are terms commonly used in options trading to describe the relationship between the current price of the underlying asset and the strike price of the option. Here’s what each term stands for:
ATM (At-The-Money)
ATM refers to a situation where the current price of the underlying asset is approximately equal to the strike price of the option. In other words, there is no significant profit or loss associated with exercising the option at the current market price. For example, if the stock is trading at Rs. 50 and the strike price of the option is also Rs. 50, it is considered an ATM option.
OTM (Out-of-The-Money)
OTM refers to a situation where the current price of the underlying asset is below (for a call option) or above (for a put option) the strike price. In this case, if the option were to be exercised, it would not result in a profit. OTM options have no intrinsic value and are dependent on the underlying asset’s price moving in the desired direction to become profitable.
ITM (In-The-Money)
ITM refers to a situation where the current price of the underlying asset is above (for a call option) or below (for a put option) the strike price. In this case, if the option were to be exercised, it would result in a profit. ITM options have intrinsic value because they can be immediately exercised for a profit.
