Strategic Financial Management · Options

Option Basics: Calls, Puts and Key Terminology

Updated 11 October 2026 · Fact-checked

An option gives its buyer the right, but not the obligation, to buy (call) or sell (put) an underlying asset at a fixed strike price on or before a set date. The buyer pays a premium. Premium = intrinsic value + time value. Solve questions by finding moneyness, then intrinsic value, then time value.

Understand Option Basics: Calls, Puts and Terminology

An option is a contract. The buyer (holder) pays a price and gets a right. The seller (writer) receives that price and takes an obligation. The buyer can choose whether to use the right. The writer cannot choose; if the buyer exercises, the writer must perform.

A call option gives the holder the right to buy the underlying at the strike price (exercise price). You buy a call when you expect the price to rise. A put option gives the holder the right to sell the underlying at the strike price. You buy a put when you expect the price to fall or want protection against a fall.

The price paid for the option is the premium. It is paid upfront and is not refunded, whether or not you exercise. The expiry date is the last date of the contract. A European option can be exercised only on the expiry date. An American option can be exercised on any day up to and including expiry. Index and stock options traded on Indian exchanges are European-style, but exam questions often state the style, so read it.

Moneyness tells you whether exercising now would pay. A call is in the money (ITM) when spot price S is above strike X, at the money (ATM) when S = X, and out of the money (OTM) when S is below X. For a put it is the reverse: ITM when S is below X, OTM when S is above X.

The premium has two parts. Intrinsic value is the gain from exercising right now, and it is never negative. Time value is the extra the buyer pays for the chance that the option becomes more valuable before expiry. Time value = premium − intrinsic value. It falls to zero at expiry, and it is highest near the money.

Key rules to remember

Intrinsic value of a call: Max(S − X, 0); S = spot price of the underlying, X = strike price. Zero if the call is ATM or OTM.
Intrinsic value of a put: Max(X − S, 0); Zero if the put is ATM or OTM.
Premium split: Premium = Intrinsic value + Time value; So time value = Premium − Intrinsic value. For an option whose premium is below intrinsic value, check the data; it signals an arbitrage or a question error.
Moneyness of a call: ITM if S > X; ATM if S = X; OTM if S < X; Compare spot with strike.
Moneyness of a put: ITM if S < X; ATM if S = X; OTM if S > X; Opposite of a call.
Net profit to buyer at exercise (per unit): Call: Max(S − X, 0) − Premium; Put: Max(X − S, 0) − Premium; Ignores interest on premium and transaction costs unless the question includes them. The writer's profit is the opposite sign.

How to solve Option Basics: Calls, Puts and Terminology questions

Use this order for any question on option terms, moneyness, intrinsic value or time value.

1Identify the type: call (right to buy) or put (right to sell), and whether you are the buyer or the writer.
2Note the style: European (exercise only at expiry) or American (any time up to expiry).
3List S (spot), X (strike) and the premium. Convert to per-unit or per-lot consistently.
4Decide moneyness by comparing S with X, using the correct direction for a call or a put.
5Compute intrinsic value: Max(S − X, 0) for a call, Max(X − S, 0) for a put.
6Compute time value = premium − intrinsic value. Time value should not be negative.
7If asked for profit, subtract the premium from the exercise gain for the buyer; reverse the sign for the writer.
8State the decision clearly: exercise, let lapse, or hold, with a one-line reason.

Quickest way: Three-line check: moneyness, intrinsic, time

When to use it: Use for MCQs that give spot, strike and premium and ask for intrinsic value, time value or moneyness.

Write the gap: for a call S − X, for a put X − S.
If the gap is positive, it is both the intrinsic value and the ITM amount. If zero or negative, intrinsic value is 0.
Time value = premium − intrinsic value. Check it is not negative, then pick the option.

Common mistakes in Option Basics: Calls, Puts and Terminology

Using S − X for a put's intrinsic value.
Students learn the call formula first and apply it to everything.
Fix: For a put, write X − S. Say it as 'strike minus spot' every time you see a put.
Showing negative intrinsic value for an OTM option.
The gap S − X is negative and gets copied as the answer.
Fix: Intrinsic value is Max(gap, 0). An option holder is never forced to exercise at a loss, so the floor is zero.
Calling a put ITM when spot is above strike.
Moneyness is memorised for calls and carried over.
Fix: Ask whether exercising pays. A put pays when you can sell above the market, which means strike above spot.
Treating premium as profit or ignoring it in net gain.
Students focus on the exercise gain only.
Fix: Buyer's net profit = exercise gain − premium. The premium is a sunk cost paid upfront, even if the option lapses.
Thinking an American option is always more valuable or always exercised early.
Confusing the right to exercise early with a reason to do so.
Fix: An American option gives extra flexibility, so it is worth at least as much as an otherwise identical European option. Early exercise is not always optimal; state only what the question asks.
Saying the writer has a right to exercise.
Mixing up the buyer and writer positions.
Fix: Only the buyer holds the right. The writer has the obligation and keeps the premium.

Worked examples

Example 1

A call option on a share has a strike price of ₹500 and a premium of ₹32. The share trades at ₹520. (a) State the moneyness. (b) Find the intrinsic value and time value. (c) Find the buyer's net profit if the option is exercised at expiry with the share at ₹520.

Show the solution

Type: call. S = ₹520, X = ₹500, premium = ₹32.
Moneyness: S (520) is above X (500), so the call is in the money.
Intrinsic value = Max(520 − 500, 0) = ₹20.
Time value = 32 − 20 = ₹12.
Net profit at expiry with S = ₹520: exercise gain = ₹20, less premium ₹32 = −₹12 per share.

Answer: The call is ITM. Intrinsic value is ₹20 and time value is ₹12. At expiry with the share at ₹520, the buyer has a net loss of ₹12 per share, since the gain of ₹20 is less than the premium of ₹32.

Example 2

A put option on an index has a strike of 22,000 and a premium of ₹150 per unit. Find the intrinsic value, time value and moneyness if the index is at (a) 21,900 and (b) 22,100.

Show the solution

Type: put. X = 22,000, premium = 150.
Case (a): S = 21,900. S is below X, so the put is in the money.
Intrinsic value = Max(22,000 − 21,900, 0) = 100. Time value = 150 − 100 = 50.
Case (b): S = 22,100. S is above X, so the put is out of the money.
Intrinsic value = Max(22,000 − 22,100, 0) = 0. Time value = 150 − 0 = 150.

Answer: (a) ITM, intrinsic value ₹100, time value ₹50. (b) OTM, intrinsic value ₹0, time value ₹150. An OTM option's premium is entirely time value.

Exam tips

In MCQs, first decide call or put, then apply the direction. Most wrong answers come from reversing the put formula.
Always check that time value is not negative. A negative result usually means you used the wrong intrinsic formula.
Read whether the question wants the buyer's or the writer's position. Writer's profit is the mirror image of the buyer's.
Write the definition in one line before the working in descriptive answers. Examiners reward clear terms such as strike, premium and expiry.
Check whether the question is per share or per lot. Multiply by lot size only if the lot size is given.

Practice questions from Options

Option Basics: Calls, Puts and Terminology in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Option Basics: Calls, Puts and Terminology: frequently asked questions

What is the difference between a call and a put option?

A call gives the holder the right to buy the underlying at the strike price. A put gives the holder the right to sell at the strike price. Buyers of calls gain when prices rise, and buyers of puts gain when prices fall.

What is the difference between European and American options?

A European option can be exercised only on the expiry date. An American option can be exercised on any day up to expiry. The rights are otherwise the same, so an American option is worth at least as much as a similar European one.

How do you calculate intrinsic value and time value of an option?

Intrinsic value is Max(S − X, 0) for a call and Max(X − S, 0) for a put. Time value is the premium minus intrinsic value. Time value falls to zero at expiry.

When is an option in the money, at the money or out of the money?

A call is ITM when spot is above strike, and a put is ITM when spot is below strike. Both are ATM when spot equals strike. Otherwise the option is OTM.