Option Basics: Calls and Puts

Options come up in the work of companies that prepare for price moves in an underlying asset and of financial institutions that trade options. Whether you hold the right as a buyer or take on the obligation as a seller changes both the size of the possible loss and whether margin is required.

A right to buy and a right to sell at a set price

An option is a right to buy or sell something at a set price, and the holder of the right can choose whether to use it. To get the right, you pay a price for it¹. How options differ from forward contracts and futures contracts, and where they fit among derivatives as a whole, is covered in What Is a Derivative?.

There are two kinds of options, a right to buy and a right to sell. The right to buy at a price fixed in advance is called a call option (call), and the right to sell is called a put option (put)². The asset bought or sold under an option is called the underlying asset, and the trade price fixed in advance is called the strike price³.

The price of the right is called the option premium, or simply the premium. Japanese materials also call it the "right fee" or the "option fee"⁴. The terms of one option are set by the following five items. Consider a hypothetical example in which you buy "the right to buy shares of Company A at 1,000 yen per share in three months" for 50 yen per share. The underlying asset is Company A's shares, the type is a call, the strike price is 1,000 yen, the expiry is three months from now, and the premium is 50 yen.

The premium is the price of the option itself, the equivalent of the share price in stock trading⁵. On an exchange, option prices change with supply and demand between sellers and buyers, just as stock and futures prices do⁶.

When the trade starts, only the premium is paid. The underlying asset and the payment at the strike price change hands only if the buyer uses the right.

The buyer's right and the seller's obligation

The buyer of an option can choose whether to use the right, but the seller is obliged to do what the buyer chooses. If the buyer uses the right, the seller of a call must sell at the strike price, and the seller of a put must buy at the strike price³. When the buyer uses the right and buys or sells the underlying asset at the strike price, this is called exercise. Not using the right is called abandonment⁷¹.

The buyer of a call exercises the right if the price of the underlying asset at expiry is above the strike price, and buys at a strike price lower than the market price. If the price is below the strike price, buying in the market is cheaper, so the buyer abandons the right. The buyer of a put does the opposite. If the price of the underlying asset is below the strike price, the buyer exercises and sells above the market price, and if it is above, the buyer abandons the right³. Take the call on Company A's shares with a strike price of 1,000 yen and a premium of 50 yen. If the share price at expiry is 1,200 yen, the buyer exercises and buys at 1,000 yen. If it is 800 yen, the buyer abandons the right. The loss when abandoning is just the 50 yen paid.

Figure description

This figure shows the profit and loss at expiry of buying a call on one Company A share. The horizontal axis is the share price at expiry, and the vertical axis is the profit and loss per share including the premium. The terms are the same as in the example in the text. Up to the strike price the right is abandoned, so the result is constant. Above the strike price, the result rises by the amount the share price rises. The loss is limited to the premium, and the profit has no upper limit. The break-even point, where the result is zero, is 1,050 yen, which is the strike price of 1,000 yen plus the premium of 50 yen.

The buyer exercises only when it pays to do so and can abandon the right when it does not, so the buyer's loss is limited to the premium paid¹. The seller, on the other hand, must comply with an exercise in exactly the cases where the buyer gains, which are the cases where the seller loses. For this reason, the seller's loss can far exceed the premium received, and the loss of a call seller has no upper limit⁸.

Because the possible losses differ in size, on an exchange the buyer of an option does not need to deposit margin, while the seller deposits margin when opening the trade⁸⁹.

The four positions in calls and puts

Calls and puts each have a buyer and a seller, so depending on which one you buy or sell, option trading has four positions¹⁰. The table shows the right or obligation each position holds, which way the price of the underlying asset must move for it to gain, and whether its loss is limited¹¹.

The seller's profit is limited to the premium received¹¹. The profit or loss at expiry of the four positions, the price at which profit or loss is zero (the break-even point), and the limits on profit and loss are compared with numerical examples and payoff diagrams in Option Payoffs and Profit/Loss.

The three states of an option

Options are described as being in one of three states, based on how the strike price compares with the current price of the underlying asset. Leaving the premium aside, suppose the buyer exercised the right now. If that would make a profit, the option is in the money (ITM). If it would make neither a profit nor a loss, the option is at the money (ATM), and if it would make a loss, the option is out of the money (OTM)¹².

Consider a hypothetical example in which the price of the underlying asset is 10,000 yen and there are three calls and three puts with different strike prices. Their states are as follows.

A call is in the money when the strike price is below the price of the underlying asset, and out of the money when it is above. A put is the opposite and is in the money when the strike price is above the price of the underlying asset. When the strike price equals the price of the underlying asset, both the call and the put are at the money¹². On an exchange, strike prices are set at fixed intervals, so the strike price closest to the price of the underlying asset is sometimes called at the money⁶.

These three states depend only on the purchase or sale at exercise. So even an option that is in the money can show a net loss once the premium paid is subtracted.

Intrinsic value and time value

An option's premium can be split into two parts, intrinsic value and time value⁵. Intrinsic value is what the option would be worth if the right were exercised now, and time value is the part of the premium above the intrinsic value⁶.

The breakdown when the price of the underlying asset is 10,000 yen is as follows.

The intrinsic value of a call is "price of the underlying asset − strike price," and the intrinsic value of a put is "strike price − price of the underlying asset." If the result is negative, the intrinsic value is zero¹³. In the table, the call with a strike price of 9,500 yen has an intrinsic value of 10,000 − 9,500 = 500 yen and a time value of 700 − 500 = 200 yen. An option that is out of the money has zero intrinsic value, so its whole premium is time value.

Time value is the value of the expectation that the price of the underlying asset will move in a favorable direction before expiry. This expectation is why a right to buy at a strike price above the current price still has a premium⁶. The main drivers of time value are the time remaining to expiry and volatility (how much the price moves). Time value tends to be higher the longer the time remaining and the higher the volatility. As expiry approaches, time value decreases, and it decreases faster the closer expiry is⁶.

The premium rises and falls as the price of the underlying asset, volatility, and the time to expiry change⁴.

Using options to prepare for price rises and falls

Buying options is a way to prepare for price moves in an underlying asset you plan to buy or sell in the future. If you are worried that an asset you plan to buy will rise in price, you buy a call. If you are worried that an asset you plan to sell will fall in price, you buy a put³.

Consider a hypothetical example in which a company that plans to buy an underlying asset in three months buys a call on the same terms as the Company A share call in the earlier example (a strike price of 1,000 yen and a premium of 50 yen). If the asset has risen to 1,200 yen after three months, the company can exercise the right and buy at 1,000 yen, so it is not affected by the rise above 1,000 yen. If the asset has fallen to 900 yen, the company can abandon the right and buy in the market at 900 yen. In either case, the premium paid is not returned. The effective purchase price is therefore the strike price or the market price plus the premium, which is 1,050 yen or 950 yen in this example¹¹⁴.

Fixing the purchase price with a forward contract avoids the loss if the price rises, but gives up the gain if the price falls. By paying the premium, buying an option limits the loss while keeping the chance of a gain¹⁴. Options are also bought on the expectation of a price rise or fall. If the price moves against that expectation, the loss is limited to the premium paid¹⁴.

Settling a trade, and an example of an exchange-traded option

There are two ways to end an option trade, holding it to expiry or making an offsetting trade before expiry. With exchange-traded options, a buyer can close the trade by selling the same option (a resale), and a seller can close it by buying the option back (a buyback). In that case, the difference between the premiums at which the option was bought and sold is paid or received⁴¹⁵.

When an option can be exercised depends on the product. An option that can be exercised only on the expiry date is called a European option, and one that can be exercised at any time until expiry is called an American option¹.

As an example of an option on a Japanese exchange, take Nikkei 225 Options on Osaka Exchange. The underlying asset is the Nikkei Stock Average. The options give the right to buy (call) or sell (put) at the strike price on the SQ day (the second Friday of the contract month, or the preceding business day if that day is a holiday). Trading began on June 12, 1989¹⁶. The main terms are as follows (as of September 2026)¹⁷.

Multiple strike prices are set at fixed intervals, centered on values close to the Nikkei Stock Average¹⁷.

Consider a hypothetical example in which you buy one unit of an option with a premium of 100 yen. Because the contract unit is 1,000 times the option price, it costs 100 yen × 1,000 = 100,000 yen.

Settlement at expiry uses the SQ value. The SQ value is a special value of the Nikkei Stock Average calculated from the opening prices of the constituent stocks on the SQ day¹⁷. If the buyer holds the option to expiry without an offsetting trade and it is in the money, the buyer receives only the difference between the strike price and the SQ value. Unlike with exercising the right, the underlying asset and payment at the strike price do not change hands¹⁵¹⁸. If the option is not in the money, the right lapses and the premium paid becomes a loss¹⁵. What changes hands at expiry is only the difference that corresponds to the intrinsic value, and no time value remains.

Notes

1. Central Council for Financial Services Information, "3-1 オプション取引とは？（やさしいデリバティブ）" (What is option trading?, Easy Derivatives, in Japanese), "デリバティブのオプションは？" (What is an option in derivatives?), "パターン（1）" (Pattern 1) and "パターン（2）" (Pattern 2) in "オプション取引のイメージ" (Picturing option trading), "先物取引とオプション取引の違い" (How futures and options differ), and "権利行使できるオプションのタイプ" (Types of options by when they can be exercised). ↩ ↩² ↩³ ↩⁴ ↩⁵

2. Japan Exchange Group, "コール・オプション（用語集）" (Glossary: call option, in Japanese) and "プット・オプション（用語集）" (Glossary: put option, in Japanese), the heading and the first sentence of each. ↩

3. Central Council for Financial Services Information, "3-2 コールオプションとプットオプション（やさしいデリバティブ）" (Call options and put options, Easy Derivatives, in Japanese), the opening, "コールオプション" (Call options), "プットオプション" (Put options), and the table in "まとめ" (Summary). ↩ ↩² ↩³ ↩⁴

4. Central Council for Financial Services Information, "3-3 オプション・プレミアム（やさしいデリバティブ）" (Option premium, Easy Derivatives, in Japanese), the opening, "プレミアムの価格が変化するタイミングの例" (Examples of when the premium changes), and "オプション取引の反対売買" (Offsetting trades in options). ↩ ↩² ↩³

5. Japan Exchange Group, "プレミアム（用語集）" (Glossary: premium, in Japanese). ↩ ↩²

6. Osaka Exchange, "プレミアム" (Premium), Kitahama Investment School (in Japanese), the opening, "銘柄によって違うプレミアム" (Premiums differ by option series), "本質的価値と時間的価値" (Intrinsic value and time value), and "時間的価値はどのように決まるのか" (How time value is determined). ↩ ↩² ↩³ ↩⁴ ↩⁵

7. Japan Exchange Group, "権利行使（用語集）" (Glossary: exercise, in Japanese). ↩

8. Central Council for Financial Services Information, "3-4 オプション取引の損益（やさしいデリバティブ）" (Profit and loss in option trading, Easy Derivatives, in Japanese), "オプション取引の買い手の立場" (The buyer's position in option trading) and "オプション取引の売り手の立場" (The seller's position in option trading). ↩ ↩²

9. Osaka Exchange, "オプション取引とは" (What is option trading?), Kitahama Investment School (in Japanese), "オプションの買い手の特徴" (Features of the option buyer) and "オプションの売り手の特徴" (Features of the option seller). ↩

10. Osaka Exchange, "オプション取引とは" (What is option trading?), Kitahama Investment School (in Japanese), the table in "オプション取引には4つの立場がある" (Option trading has four positions). ↩

11. Central Council for Financial Services Information, "3-4 オプション取引の損益（やさしいデリバティブ）" (Profit and loss in option trading, Easy Derivatives, in Japanese), the descriptions of buying and selling calls and puts in "各オプションの買い手・売り手の双方の損益" (Profit and loss of both the buyer and the seller of each option). ↩ ↩²

12. Japan Exchange Group, "イン・ザ・マネー（ITM）（用語集）" (Glossary: in the money (ITM)), "アット・ザ・マネー（ATM）（用語集）" (Glossary: at the money (ATM)), and "アウト・オブ・ザ・マネー（OTM）（用語集）" (Glossary: out of the money (OTM)), all in Japanese. ↩ ↩²

13. Japan Exchange Group, "本質的価値（用語集）" (Glossary: intrinsic value, in Japanese). ↩

14. Central Council for Financial Services Information, "3-5 オプション取引活用の例（やさしいデリバティブ）" (Examples of using options, Easy Derivatives, in Japanese), "通貨オプションの例" (Currency option example) under "ヘッジング" (Hedging), and "先行きの予測に応じた投資" (Investing based on a market outlook). ↩ ↩² ↩³

15. Osaka Exchange, "決済方法（オプション）" (Settlement methods: options), Kitahama Investment School (in Japanese), "反対売買による決済" (Settlement by offsetting trades), and "権利行使" (Exercise) and "権利放棄（権利消滅）" (Abandonment (lapse of the right)) under "SQ値による決済" (Settlement at the SQ value). ↩ ↩² ↩³

16. Japan Exchange Group, "日経225オプション 商品概要" (Nikkei 225 Options: product overview, in Japanese), the main text, and the "取引開始日" (Trading start date), "取引最終日" (Last trading day), and "SQ日" (SQ day) rows of "日経225オプション 制度概要" (Nikkei 225 Options: contract specifications, in Japanese). ↩

17. Japan Exchange Group, "日経225オプション 制度概要" (Nikkei 225 Options: contract specifications, in Japanese), the "原資産" (Underlying asset), "SQ日" (SQ day), "権利行使日" (Exercise date), "取引単位" (Contract unit), "権利行使価格" (Strike prices), and "オプション清算数値（SQ値）" (Option settlement value (SQ value)) rows. Checked on September 24, 2026. ↩ ↩² ↩³

18. Japan Securities Clearing Corporation, "指数オプション取引の決済方法" (Settlement methods for index options, in Japanese), "指数オプション取引の決済方法について" (About settlement methods for index options). ↩