Put simply, stock market trading involves buying and selling shares through an exchange to make a profit. But is it that simple? Technology has made access to financial markets easier and, in a sense, a tad complicated for retail investors. Experienced share market traders would be familiar with options trading—financial contracts that give traders the right to buy or sell assets at a predetermined price over a fixed period. Call Options (CE) and Put Options (PE) are essential terms to understand if you wish to try your hand at options trading.
Understanding CE and PE can open up exciting trading opportunities, whether you’re looking to boost profits or protect your portfolio. This blog post will explain the basics of CE and PE and provide you with all the ammo to ace options trading.
Understanding CE and PE in the stock market
CE stands for Call European, commonly known as a call option. In other words, it’s an investment contract that gives the buyer the right (but not the obligation) to purchase an asset—like stocks, bonds, or commodities—at a set price (called the strike price) within a specific time frame. If the asset’s price rises above the strike price, the buyer benefits by buying at a lower rate.
On the other hand, PE stands for Put European or simply a put option. It gives the holder the right (but not the obligation) to sell an asset at the strike price within a predetermined period. This works best when an investor expects the asset’s price to fall.
Every options trade involves a buyer and a seller. Just as you can’t buy a call option without someone selling it, put options require a corresponding buyer.
Differences between CE and PE
CE and PE are two types of options in the stock market. Here are some of the significant differences between them:
| Aspect | CE | PE |
|---|---|---|
| Expansion | Call European | Put European |
| Contract type | Right to buy an underlying asset at a set price before expiry | Right to sell an underlying asset at a set price before expiry. |
| Profitability | Profitable if the asset’s market price exceeds the strike price. | Profitable if the asset’s market price drops below the strike price. |
| When to buy | When you expect the price of the asset to rise. | When you expect the price of the asset to fall. |
| Example | Buy CE if you think the stock price will go up. | Buy PE if you think the stock price will go down. |
Both options offer profit potential with limited risk, making them popular among stock market traders.
Understanding the CE and PE ratio
The put/call ratio is a popular indicator that investors use to gauge the state of the market. A high ratio suggests that traders are pessimistic, where they buy more puts than calls. The converse is true for a low ratio. If traders buy more calls over puts, one could expect a bull market.
Importance of the CE and PE ratio in stock analysis
CE and PE ratios help traders assess the future trajectory of an asset class. They help them remove bias from any analysis and enable them to make wise options trading decisions.
That said, it is not a good idea to base a trading decision on a single metric. If used in conjunction with other metrics, the put/call ratio can be of great use to traders.
How to calculate the CE and PE ratio
Two formulas are available to calculate the Put/Call Ratio (hereafter PCR). The first option is as follows:
PCR = Put Quantity/Call Quantity
Here, the Put Quantity and Call Quantity represent the total number of put and call options traded on a given day.
Another way to calculate PCR is as follows:
PCR = Net Put Open Interest/Net Call Open Interest
As an illustration, the PCR for an asset is 1,250/1,785, or 0.7, if, on a particular day, there were 1,250 puts and 1,785 calls traded for the asset.
Understanding the CE and PE ratio in the stock market
The Put/Call Ratio (PCR) measures market sentiment by comparing the number of put options (PE) to call options (CE). Here’s how to interpret it:
- High PCR (> 0.7 or 1): Suggests a bearish market sentiment. Traders may be buying more puts to protect against a drop.
- Low PCR (0.5 – 0.7): Indicates bullish sentiment, with more calls being purchased.
- PCR = 1: Equal puts and calls, offering no clear market direction.
Extreme PCR levels reveal how investors feel about recent news or earnings, signaling potential market shifts.
CE and PE ratio as indicators of stock valuation
A very high put/call ratio typically indicates that the stock market is volatile. However, a contrarian might see this as a bullish indicator. They may argue that since the market has been too negative, it is poised for a reversal. Therefore, a contrarian may view a high ratio as a good time to purchase.
Similarly, a lower ratio indicates that market bullishness is high. However, a contrarian may conclude that the stock market is overbought and is overdue for a downturn.
Anyone ratio cannot, therefore, singlehandedly accurately predict a peak or bottom. Even the ranges of the ratio change over time and are not fixed.
Investors usually compare current ratio readings to the long-term averages to determine a change in sentiment. For instance, when PCR abruptly increases after fluctuating in a narrow range, traders may interpret this as a sudden rise in negative sentiment and act accordingly.
From all of this, it must be clear that a healthy dose of caution and DYOR is a prerequisite before entering the options world.
FAQs
What is the expansion of CE in the stock market?
In the context of the stock market, “CE” stands for “Call Option European Style.”
What are call and put options?
A call option is a financial contract that gives the buyer the right, but not the obligation, to buy an underlying asset at a predetermined price (strike price) within a specific time period. A put option, on the other hand, gives the buyer the right, but not the obligation, to sell an underlying asset at a predetermined price (strike price) within a specific period.
What is the difference between buying CE and selling PE?
Buying a CE (Call Option European Style) means acquiring the right to buy the underlying asset at a specified price within a specific time frame. Selling a PE (Put Option European Style) means you are granting someone else the right to sell the underlying asset at a specified price within a specific time frame. In short, buying a CE gives you the option to purchase, while selling a PE grants someone else the option to sell.
What is the strike price in options trading?
The strike price, also known as the exercise price or the striking price, is the predetermined price at which the underlying asset can be bought or sold when exercising an options contract. It is the price at which the buyer of the option has the right to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset.
What is a good PE ratio?
PE (Price-to-Earnings) ratio can vary depending on the industry and market conditions. Generally, a lower PE ratio may suggest that a stock is relatively undervalued, while a higher PE ratio may indicate it is overvalued. However, it is important to consider other factors like growth prospects, industry comparisons, and company-specific circumstances when evaluating the attractiveness of a stock based on its PE ratio.
What are F&O PE and CE?
F&O stands for Futures and Options. PE refers to Put Option European Style, which gives the holder the right to sell the underlying asset. CE refers to Call Option European Style, which provides the holder the right to buy the underlying asset. These are standard terms used in the derivatives market for trading options contracts.
