Financial derivatives, known as options, provide their holders the ability to purchase or sell an underlying asset at a predefined price within a predefined time period. However, for profitability in this market, traders need to understand how to calculate call and put options prices.
In this article, we’ve mentioned a simple and effective process for the same. Without any delay, let’s start the article!
What is the Call Option?
A call option is a contract that gives you the right to purchase a specific underlying asset for a specified price within a time frame. It can be stocks, commodities, bonds, or other securities.
The call option gains greater worth if the underlying asset’s price increases before expiration. That is because, even if the underlying asset is now worth more in the market, you can use your option to purchase it at the lower strike price. You can learn option trading from scratch on Upsurge. club.
What is the Put Option?
A put option is a contract that gives you the right to sell a specific underlying asset for a specified price within a time frame. If the price of the underlying asset falls below the strike price before the expiry date, your put option gains its worth. This is so because, instead of selling the asset at the lower market price, you may still sell it at the higher strike price.
How to Calculate Call Option and Put Option?
Here is how you can calculate the call and put option price:
Call Option Price
A call option’s price is determined by the Black-Scholes model, using a number of variables, including the strike price, time until expiry, market volatility, and the underlying asset’s current price.
Call Option Price = N(d1) * S – N(d2) * Ke^(-rt)
Where,
- N(d1) and N(d2) represent probability distributions.
- S = Underlying assets’ current price
- K = Strike price
- r = Interest rate without risk
- t = Number of years till expiry
Let us compute the call option price for a stock having, for instance:
S = ₹3,750 (stock price as of right now).
K = 3,375 (strike price)
r = 6% (risk-free interest rate)
t = 0.5 years (6 months remain to expiry)
σ = 0.3 (30% stock volatility)
According to the Black-Scholes model, a call option would cost around ₹562.
Put Option Price
The price of a put option may be estimated using the put-call equivalence relationship, which connects the prices of call and put options for the same asset.
Put Option Price = Call Option Price (₹562) – S + Ke^(-rt)
Taking the identical values from the call option example above:
Put Option Price = ₹562 – ₹3,750 + ₹3,375e^(-0.06 * 0.5) = ₹169
Note: In this case, the 6% risk-free interest rate is only an assumption. For precise computations, you should use the relevant risk-free rate.
Conclusion
For potential traders who want to learn option trading from scratch, precise calculation of call and put option pricing is essential. To learn more about stock market basics for beginners, enroll in online courses from Upsurge.club.