THE DISTINCTIVE GAME OF PUT OPTION AND CALL OPTION

Call and put options are two types of financial contracts used in options trading. Both types of options give the holder the right, but not the obligation, to buy or sell an underlying asset at a specified price on or before a specified date. In this article, we will explain what call and put options are, how they work, and provide a recent case study to illustrate their use.

What is a Call Option?

A call option is a financial contract that gives the holder the right to buy an underlying asset at a specified price, known as the strike price, on or before a specified date, known as the expiration date. Call options are commonly used by traders who are bullish on the underlying asset and expect the price of the asset to rise.

When a trader buys a call option, they pay a premium to the option seller, known as the option writer. The premium is the price of the option and is determined by several factors, including the strike price, the current price of the underlying asset, the time to expiration, and the level of volatility in the market.

If the price of the underlying asset rises above the strike price, the holder of the call option can exercise the option and buy the underlying asset at the strike price, which is lower than the market price. The holder can then sell the asset in the market at a higher price and make a profit. If the price of the underlying asset does not rise above the strike price, the holder of the call option can let the option expire, and they will only lose the premium paid for the option.

What is a Put Option?

A put option is a financial contract that gives the holder the right to sell an underlying asset at a specified price, known as the strike price, on or before a specified date, known as the expiration date. Put options are commonly used by traders who are bearish on the underlying asset and expect the price of the asset to fall.

When a trader buys a put option, they pay a premium to the option seller. The premium is the price of the option and is determined by several factors, including the strike price, the current price of the underlying asset, the time to expiration, and the level of volatility in the market.

If the price of the underlying asset falls below the strike price, the holder of the put option can exercise the option and sell the underlying asset at the strike price, which is higher than the market price. The holder can then buy the asset back at the lower market price and make a profit. If the price of the underlying asset does not fall below the strike price, the holder of the put option can let the option expire, and they will only lose the premium paid for the option.

Tesla's Call Options

In February 2021, Tesla's shares skyrocketed, thanks to its successful earnings report. The price of Tesla shares increased from $850 to $880 within a few hours. As a result, many traders bought call options, expecting the price of the stock to continue to rise.

One trader, known as the "Tesla Whale," made a massive bet on Tesla's call options, spending over $200 million. The trader purchased a total of 235,000 call options with a strike price of $800 and an expiration date of March 19, 2021.

The trader's bet paid off, as Tesla's share price continued to rise, reaching an all-time high of $900.40 on February 9, 2021. The trader sold their call options for a profit of $1.08 billion, making it one of the biggest single-day options trades in history.

What is the position of RBI and SEBI regarding Call/Put Options?

Prior to Indian regulators' attention being drawn to investment agreements, call/put options were widely prevalent. However, Indian regulators such as SEBI and RBI expressed their opposition to such contracts, citing different reasons for their disapproval.

SEBI's objection was based on the provisions outlined in the SCRA (Securities Contract (Regulation) Act, 1956), which stated that derivatives are only permitted if they are listed on stock exchanges. Therefore, SEBI believed that any private contractual agreement involving options between two parties would be in violation of Section 18A of the SCRA. However, SEBI later acknowledged that its interpretation of Section 18A was Improbable and agreed to allow call/put options under specific conditions laid down in its notification dated 3rd October 2013.

On the other hand, RBI was against allowing such contracts as it believed that these contracts ensured a valid exit for foreign investors. Despite this, RBI issued a circular dated 9th January 2013, allowing call/put options to be included in investment agreements, a welcome step in the inclusion of such options. RBI, however, still maintains its stand that these options are responsible for creating "debt-like instruments," and has attempted to regulate them by limiting them to certain specified conditions, as mentioned in its circular.

The Companies Act, 2013 has introduced new provisions such as Section 58(2) and 194 to recognize and facilitate the inclusion of put and call options in share transfer agreements

Conclusion

In conclusion, call and put options are two essential instruments in the world of finance. They provide investors with the flexibility to participate in the markets while managing risk effectively. Call options give the holder the right to buy an underlying asset at a predetermined price, while put options give the holder the right to sell an underlying asset at a predetermined price. Understanding the mechanics of these instruments is crucial for investors to make informed decisions and achieve their investment objectives. As with any investment, it is important to do your due diligence, consult with a financial advisor, and consider your risk tolerance before investing in call or put options.