Put-Call Ratio: Definition, How It Works, Advantages and Strategy

The put-call ratio, a popular sentiment indicator, assesses the ratio of put options to call options traded in a day. Puts bet on falling prices, while calls anticipate a rise. A high ratio signals bearish sentiment, and a low ratio is bullish.

Traders calculate the ratio by dividing total put options by total call options traded, often at the day’s end. Ratios above 1 indicate more puts traded. Levels above 0.70-0.80 are bearish, and below 0.50 are bullish. Monitoring 10 or 21-day moving averages reveals sentiment shifts over time.

The advantages of the put-call ratio include its role as a contrarian indicator. Extreme readings historically coincide with market tops or bottoms. It reflects experienced options traders’ sentiment, providing early signals for price movements. Divergences and moving average crossovers against the market direction highlight low-risk entry points.

What is the Put-Call Ratio?

The put-call ratio is a key technical indicator that assesses options market sentiment by comparing put and call trading volumes. It reflects the number of put options traded divided by call options during a specified period.

A higher put-call ratio, indicating more puts traded than calls, suggests a bearish sentiment. Puts profit from falling stock prices, while calls profit from rises. Traders may buy more puts to bet on or hedge against market declines. Conversely, a lower put-call ratio signals bullish sentiment, anticipating rising stock prices. An excessively low ratio may indicate overconfidence and a potentially overheated market, potentially leading to a correction.

Traders analyze three main put-call ratios to understand market sentiment. The Total Put-Call Ratio assesses activity across all options markets. Readings above 0.7-0.8 imply bearishness, while lower readings suggest bullishness. The Equity Put-Call Ratio focuses on options for individual stocks, reflecting sentiments toward the overall stock market. The Index Put-Call Ratio considers major market indexes.

Technical analysts use put-call ratios to anticipate reversals based on trends and extreme levels. For instance, a ratio above 1.0 signals oversold conditions, while below 0.40 could indicate overbought conditions. However, interpretation is nuanced, and combining the put-call ratio with other indicators enhances its effectiveness.

Various sophisticated variations of the basic put-call ratio have been developed, incorporating moving averages, equity-only ratios, open interest, oscillators, adjusted ratios, composites, commitments of traders data, and zero-basis ratios. These refinements aim to filter distortions, improve signal quality, isolate speculative activity, and provide a clearer picture of sentiment and expectations in the options market.

While the put-call ratio serves as a valuable contrarian indicator for understanding emotions and price trends, analysts recommend using it in conjunction with other indicators to validate signals and avoid false readings. Careful analysis of put-call ratios enables traders to identify potential market tops and bottoms, but context is crucial for extracting meaningful insights.

How Does Put-Call Ratio Work?

The put-call ratio operates by comparing put option volume to call option volume during a specific period, providing insights into options market sentiment. High ratios suggest bearishness, while low ratios indicate bullishness. The ratio is calculated by dividing the total put option contracts traded by the total call option contracts traded.

How Does Put-Call Ratio Work

Traders buy put options to profit from expected price declines and call options for anticipated price rises. Monitoring the volumes of these options helps gauge market sentiment. A higher put volume signifies bearish sentiment, while higher call volume indicates bullishness.

There are three primary put-call ratios: Total Put-Call Ratio, Equity Put-Call Ratio, and Index Put-Call Ratio. The Total Ratio offers an overall market sentiment snapshot, the Equity Ratio focuses on individual stocks, and the Index Ratio reveals sentiment toward major market indexes.

The equity put-call ratio filters out index option noise, while the index ratio isolates overall market sentiment. Raw ratios have limitations, so analysts use refined versions, incorporating moving averages, equity-only ratios, open interest, oscillators, adjusted ratios, composites, commitments of traders’ data, and zero-basis ratios.

The contrarian interpretation of the put-call ratio is its key appeal. High ratios may signal market bottoms, while low ratios suggest potential tops. However, nuances exist, such as high ratios confirming negative bias after a long downtrend. Additionally, high put activity may indicate institutional hedging rather than speculation.

Understanding the put-call ratio mechanism allows traders to capitalize on crowded trades and interpret market sentiment. However, it should be used cautiously, considering its nuances and in conjunction with other indicators for a comprehensive analysis.

What is the Importance of Put-Call Ratio?

The importance of the put-call ratio is that it acts as a contrarian indicator to identify extremes in investor sentiment that tend to mark major market turning points and provide trading opportunities. Marked extremes in the put-call ratio often mark inflection points where trends are exhausted. High put-call ratios signal high pessimism levels that are unsustainable and due to reverse into bullishness. Low put-call ratios flag euphoria that may soon face disappointment. These extremes exhibit conditions where traders have become overly committed on one side of the market, creating an opportunity for the contrarian trader.

The ratio measures traders’ willingness to pay premiums for protection or upside speculation. Declining put-call ratios signal risk appetite is strong as market participants buy calls to capture the upside. Rising ratios show risk aversion as puts are purchased to hedge the downside. The put-call ratio helps gauge shifts in emotions and expectations driving markets.

When Do Traders Use Put-Call Ratio?

Traders utilize the put-call ratio for various strategic purposes, including identifying market turning points, confirming trend shifts, fading overcrowded trades, assessing positioning ahead of major events, trading volatility, and pinpointing inflection points across different markets and time frames. This versatile tool is applied by traders across multiple asset classes and time frames.

Swing traders, focusing on medium-term stock movements, often analyze daily or weekly put-call ratios. Ratios below 0.60 may signal potential upside exhaustion, prompting traders to consider selling or shorting a stock. Conversely, ratios exceeding 0.90 could indicate capitulation, providing a buying opportunity. The 21-day moving average is commonly employed to filter out noise and provide a steadier indicator.

High put-call ratios near capitulation lows are instrumental in identifying climactic selling exhaustion. For instance, put-call ratios on the S&P 500 surpassing 1.2 reflect extreme bearishness, suggesting a possible washout bottom. Traders typically wait for the confirmation of the first higher low before entering long positions.

Trend Confirmation Tool

As a trend confirmation tool, falling put-call ratios validate upside breakouts from trading ranges, while rising ratios confirm downside breakouts. This approach aligns traders with the prevailing momentum. Contrarian traders, on the other hand, opt to fade the crowded trade when sentiment becomes heavily skewed towards one side. For instance, very low 10-day equity put-call ratios around 0.40 could indicate euphoria, prompting contrarian traders to consider put options or short positions.

Ahead of earnings events, the put-call ratio serves as an indicator of conservative positioning and downside protection. A high ratio suggests cautious sentiment, potentially leading to a positive surprise and relief rally. Conversely, a low ratio indicates optimistic sentiment, making the stock susceptible to disappointment. Rising put-call ratios point to increased demand for volatility through put options, potentially prompting a volatility expansion trade using VIX calls or futures. Conversely, falling ratios may signal volatility complacency, providing an opportunity to fade with VIX puts or futures.

Oversold rallies are common when the put-call ratio spikes above 1.0 or its 21-day moving average in a falling market. This oversold condition often indicates a temporary low and a rebound within the broader downtrend. Comparing put-call ratios across sectors allows traders to identify relative bullish or bearish positioning. Traders may act on extremes, rotating into sectors exhibiting excessive pessimism and exiting those showing optimism.

Around major events such as FOMC meetings, high put-call ratios indicate conservative positioning and downside hedging, leaving room for positive surprises and relief rallies. Conversely, low ratios signal unhedged euphoria and vulnerability. Major market bottoms are characterized by high put-call ratio spikes, often exceeding 1.2. Oversold peaks over 1.0 in a declining market can also signal potential reversal points. Major market tops, on the other hand, see put-call ratio lows under 0.60, reflecting a sense of complacency.

What are the Advantages of Using the Put-Call Ratio as an Indicator?

The advantages of using the put-call ratio as an indicator are diverse and valuable for traders, providing key insights and aiding decision-making. Here are the main advantages:

  1. Contrarian Signal: The put-call ratio serves as a contrarian indicator, offering signals at extremes to identify capitulation bottoms and euphoric tops. This allows traders to go against the crowd at major turning points.
  2. Robust Leading Indicator: Put-call extremes often precede price reversals, providing traders with an edge in identifying emerging trend changes.
  3. Universal Application: The put-call ratio is applicable across various markets, including stocks, ETFs, indexes, and commodities. It can be utilized for short-term day trading as well as long-term analysis.
  4. Versatile Uses: Traders can use the ratio for multiple purposes, such as identifying oversold bounces, gauging event positioning, executing volatility trades, monitoring sector rotations, and more. It is not limited to overbought/oversold reversals.
  5. Smooth Data Series: Moving averages of the ratio filter out noise, creating a smooth and reliable oscillator that facilitates clear signals.

Other Advantages

  1. Easy Calculation: The basic calculation of the ratio is straightforward, allowing traders to easily track it themselves without relying on third-party tools.
  2. Improves Timing: Major peaks and troughs consistently coincide with extremes in the put-call ratio, enhancing the timing of swing trade entry and exit points.
  3. Risk Management: High put-call ratios indicate conservative positioning, defining lower-risk opportunities. Conversely, low ratios indicate euphoria and higher risk.
  4. Trend Confirmation: Rising put-call ratios confirm bearish momentum, while falling ratios confirm bullish momentum, providing robust signals for trend trades.
  5. Predicts Volatility Changes: Spikes in the ratio indicate an uptick in volatility while declining ratios predict decreasing volatility, offering opportunities for volatile trades.
  6. Sentiment Insights: The ratio reveals whether traders are paying more for protection or engaging in upside speculation, offering insights into shifts in fear, greed, and expectations.
  7. Uncovers Overcrowded Trades: Extremely high or low put-call ratios expose overly crowded sentiment that is ready to reverse, allowing traders to profitably fade lopsided positioning.
  8. Market Breadth Data: Comparing put-call ratios across indexes, stocks, and sectors provides valuable information about the breadth of sentiment in the market.

In summary, the put-call ratio, in its various forms, is a powerful and versatile indicator that offers traders diverse advantages, helping them identify high-probability opportunities, manage risks effectively, confirm trends, anticipate volatility changes, and profit from extremes in investor psychology. While it can be a robust standalone indicator, its true potential is realized when integrated into a comprehensive trading strategy.

What are the Disadvantages of Using the Put-Call Ratio as an Indicator?

The put-call ratio, while a valuable indicator, comes with its set of disadvantages that traders should be aware of. Here are the main drawbacks:

  1. Noise in Raw Data: The daily put-call ratio can produce rapid oscillations and occasional false signals. Smoothing techniques, such as moving averages, are necessary to filter out noise.
  2. Not a Timing Indicator Alone: The ratio identifies potential turning points, but it should not be solely relied upon for timing entries and exits. Other indicators need to confirm signals.
  3. No Clear Thresholds: There are no universally accepted overbought or oversold levels for the put-call ratio. Traders must subjectively determine extreme zones or use backtesting to establish thresholds.
  4. Lagging Confirmation: The put-call ratio tends to confirm turns rather than lead them. It is recommended to use it in conjunction with leading indicators for more effective timing.
  5. Conflicting Interpretation: High put-call ratios may signal excessive pessimism and capitulation, but they can also justify bearish momentum, leading to conflicting interpretations.
  6. Vulnerable to Shocks: Sudden volatility spikes from unexpected news events can generate extreme, one-off readings that do not necessarily signal sustainable turns in the market.
  7. No Signal Direction: The put-call ratio, by itself, does not define market direction. It should be combined with a thorough price action analysis for a comprehensive view.
  8. Hard to Track Precisely: Exchanges may not fully report put and call volumes, leading to incomplete data. This lack of precision can affect the reliability of the ratios.
  9. Sophisticated Analysis Required: Successful use of the put-call ratio often requires advanced interpretations and combinations with other indicators, making it less accessible for less experienced traders.
  10. No Insight on Magnitude: The indicator does not provide information about the magnitude of a subsequent move, only the likelihood of a reversal.

Some Other Disadvantages

  1. False Breakouts: The crowd is often correct near major support and resistance levels, leading to failed breakouts that negate signals from the put-call ratio.
  2. Unreliable in Ranges: The ratio tends to generate choppy and whipsaw signals during trading ranges, making it less effective in such market conditions.
  3. Weak Without Confirmation: On its own, the put-call ratio can easily produce false signals. Confirmation from other indicators is essential for more reliable signals.
  4. Ineffective for Timing Exits: While useful for suggesting potential entry points, the put-call ratio may not be as effective for timing profitable exits.
  5. Difficult to Implement for Individuals: Retail traders may lack access to sufficient data to consistently calculate precise put-call ratios, making it challenging for individuals to rely on the indicator for reliable signals.

In summary, the put-call ratio, despite its advantages, requires careful consideration of its limitations. Traders should be mindful of these drawbacks and use the indicator in conjunction with other tools and indicators for a more comprehensive and accurate analysis of market conditions.

How Does Put-Call Ratio Become a Bullish Trend?

When the put-call ratio (PCR) remains at extremely low levels during an extended rally, reflecting peak complacency, and then rises as excessive call buying unwinds and put volume picks up during a market decline, it becomes a bearish trend indicator.

A rising PCR is generally considered bearish, while a decreasing PCR is viewed as bullish. The higher PCR indicates greater put option trading volume compared to call volume, signaling that more traders are anticipating lower prices. Conversely, a declining PCR suggests less put volume relative to call volume, indicating an expectation of rising prices.

The PCR signals a reversal from a bullish to a bearish trend when it falls to extremely low levels. Initially, as the market rallies, the PCR declines due to increased call buying by traders expecting rising prices. In a euphoric advance, the PCR may sink to very low levels below 0.5, driven by heavy call buying and a lack of put positions, indicating excessive bullishness and complacency. As the rally loses momentum, the low PCR levels start to rise. With the market topping out, traders unwind bullish call positions, leading to a decrease in call volume, and some begin opening put trades to speculate on a downward move.

Rise in Put Volume

The rise in put volume relative to call volume causes the PCR to increase from its extremely depressed levels. The climbing PCR during a potential market top indicates a shift from a bullish to a more cautious sentiment. As optimism diminishes, the PCR may surge back above 1.0 and continue to rise. A PCR climbing above 1.0 suggests growing pessimism, as puts allow traders to profit from market declines. As the downtrend accelerates, the PCR may rise to extremes above 1.5 or 2.0, driven by heavy put buying and a lack of call positions, reflecting a deepening bearish sentiment.

The PCR remaining at unsustainably low levels below 0.5 during an extended rally, followed by a spike higher, marks a trend reversal from bullish to bearish. The initial low PCR signifies excessive optimism and complacency. As the market tops out, the rising PCR indicates worsening sentiment, with traders covering bullish calls and opening bearish puts. This turn in the PCR signals the likelihood of a bearish trend underway.

How to Use Put-Call Ratio as Indicator for Trading?

The put-call ratio serves as an indicator for trading by helping identify sentiment extremes to pinpoint potential overbought or oversold conditions. Traders utilize this ratio to look for trend reversals when it reaches peak or trough levels, combining its signals with analyses of price action and other indicators to precisely time entries and exits. Here are five key ways in which traders effectively use the put-call ratio:

How to Use Put-Call Ratio as Indicator for Trading

Identify Overbought/Oversold Conditions:

  1. Gauge sentiment extremes using the put-call ratio, with readings above 1.0 indicating bearish sentiment and readings below 1.0 signaling bullish sentiment.
  2. During market declines, a high PCR above 1.5 or 2.0 suggests an oversold market, signaling a potential bottom.
  3. In rallies, a low PCR near 0.5 reflects an overbought market, potentially signaling a top.
  4. Traders use extreme PCR levels to enter counter-trend trades or take profits in the direction of the prevailing trend.

Spot Trend Reversals:

  • Use the PCR to spot trend reversals, with a peak above 1.5 after a downtrend indicating capitulation and a bullish reversal.
  • A trough below 0.5 after an uptrend signals exhaustion and a bearish reversal ahead.
  • Traders anticipate and enter trend reversals when the PCR reaches extreme levels and then starts moving in the opposite direction.

Compare With Price Action:

  1. Combine PCR signals with analysis of price action and other indicators.
  2. Validate high PCR readings signaling oversold conditions with the market bouncing off support.
  3. Validate low PCR readings indicating overbought conditions with price resistance at key levels and other indicators showing divergence.

Understand Limitations:

  1. Recognize that the PCR works best for major trend reversals and identifying sentiment extremes, and its signals can be early.
  2. Understand that the PCR can stay at elevated or depressed levels for extended periods during strong bull or bear trends.
  3. Utilize the indicator to gauge sentiment rather than as a strict trading system.

Adjust Inputs for PCR:

  1. Tweak the PCR to focus on different option expirations; for example, use a PCR weighted to near-term options for earlier signals on sentiment shifts.
  2. Adjust the formula to compare puts to call volume based on the money involved in trades rather than raw volume for a more accurate picture of trader sentiment.

The put-call ratio is a valuable sentiment indicator for determining investor psychology. When combined with diligent price analysis, it helps improve the timing of entries and exits. The PCR is most useful for confirming sentiment extremes and reversals rather than providing absolute buy/sell signals on its own. In the right context, it becomes a valuable component of a trader’s analytical toolkit.

What is the Best Strategy for Put-Call Ratio?

The best strategy for utilizing the put-call ratio involves integrating it as a supplementary indicator to confirm price action signals, focusing on extremes and directional changes in the ratio, and customizing inputs across multiple time frames to identify sentiment shifts and market reversals. The PCR is most effective when used in conjunction with price action analysis.

Best strategy for the put-call ratio:

Confirmation with Price Action:

  1. Use the PCR as a confirmation tool for price action signals. For instance, a high PCR reading above 1.5, when coupled with the market bouncing off a key support level, provides a stronger reversal signal.
  2. Always confirm PCR signals against prevailing price trends and key levels.

Spotting Divergence for Momentum Changes:

  1. Identify divergence between price and the PCR to spot changing momentum.
  2. Bearish PCR divergence occurs when the market sets new highs, but the PCR doesn’t break through new lows, signaling a potential top formation.
  3. Bullish divergence signals a potential market bottom.

Focus on Extreme Readings:

  1. Valuable signals from the PCR occur at extremes. A PCR above 2.0 reflects intense pessimism, while a PCR below 0.5 indicates euphoria.
  2. Extreme readings are prone to revert back to the mean and indicate major trend changes. Avoid acting on minor PCR movements and wait for extremes.

Identifying Reversals with Changing Direction:

  1. Look for changes in the direction of the PCR as a key signal for reversals.
  2. After a sustained uptrend, watch for the PCR to bottom out and start ticking higher, indicating bearish momentum gaining traction as the rally stalls.
  3. Confirm the reversal when the PCR moves back above 1.0.

Analysis Across Different Time Frames:

  1. Analyze the PCR across short, medium, and long-term time frames.
  2. The weekly PCR helps identify lasting sentiment shifts, while the daily PCR provides near-term overbought/oversold readings.
  3. Utilize a 21-day moving average of the PCR to smooth out daily fluctuations.

Customizing Inputs for Nuanced Readings:

  1. Modify the PCR calculation by weighing near-term options more heavily or analyzing dollars traded rather than raw volume.
  2. Adjusting these inputs provides a more nuanced sentiment reading and potentially earlier reversal signals.

In conclusion, the put-call ratio is most effective when integrated into a comprehensive trading strategy, using it to confirm signals, identify extremes, and adapt to changing market conditions across different time frames.

How Does Open Interest Related to Put-Call Ratio?

Open interest adds essential context to the analysis of put and call positions over time, complementing the put-call ratio’s immediate sentiment assessment based on trading volume. While the put-call ratio (PCR) gauges market sentiment by comparing put and call trading volumes, open interest offers a broader perspective on the options market structure. Examining trends in open interest alongside the PCR provides a more comprehensive understanding.

Open interest represents the total number of outstanding option contracts that remain open, reflecting the overall activity in the options market. It increases when new positions are opened and decreases when existing positions are closed. By observing open interest alongside the PCR, traders can assess the scale and persistence of option positions.

Total put open interest and call

Total put open interest and call open interest metrics reveal the breadth of activity on the bearish (put) and bullish (call) sides, respectively. Contrasting put open interest with call open interest indicates whether more traders hold bearish put positions or bullish call positions. While the PCR focuses on daily volume, open interest provides insight into the accumulation of positions over time. A high PCR may indicate greater put volume for the day, but open interest reveals whether significant put or call positions have been amassed over an extended period.

For instance, a surge in intraday put trading may spike the PCR, but if call open interest remains persistently high, it suggests an overall bullish sentiment. This additional context complements the PCR’s volume analysis.

Traders can glean valuable insights by comparing PCR movements with trends in open interest. A rising PCR combined with increasing open interest signals a strengthening bearish momentum with a buildup of bearish positions. Conversely, a falling PCR alongside rising call open interest suggests a strengthening bullish momentum as more traders initiate call positions.

Analyzing the PCR and open interest trends together helps distinguish between temporary shifts in sentiment and lasting changes. For example, a spike in the PCR with stable put open interest may indicate short-term bearish betting, while a low PCR with declining call open interest suggests waning bullish activity rather than sustained optimism. The combined analysis of the PCR and open interest provides a clearer understanding of the nature and duration of shifts in market sentiment.

How Can Volume be Used for Put-Call Equation?

Volume adds valuable context to the analysis of market sentiment through the put-call ratio (PCR), offering insights into the intensity of put/call demand and market participation. While the standard PCR calculation relies on the daily trading volume of put and call options, examining volume trends in conjunction with the PCR provides a more comprehensive understanding of market dynamics.

Volume, in the context of options, represents the total number of contracts traded within a specified time period. Higher volume indicates increased trading activity and greater investor interest, while lower volume suggests reduced participation.

The traditional PCR formula is expressed as:

���=Put VolumeCall VolumePCR=Call VolumePut Volume​

This ratio compares the trading volume of put options to call options, assessing whether more puts or calls are being traded on a given day. However, analyzing the absolute levels of volume enhances the interpretation of PCR signals.

For instance, a rising PCR accompanied by an increase in put option volume indicates strong conviction behind bearish trades. Conversely, a rising PCR with declining volume suggests weaker bearish sentiment. A spike in PCR on high volume signifies intense downside momentum, while a PCR spike on low volume reflects limited capitulation.

Considering volume trends alongside the put-call ratio provides additional insights. A high PCR reading combined with a rise in put option volume signals robust downside momentum. Conversely, a low PCR accompanied by increasing call option volume indicates growing bullish enthusiasm.

Interpreting PCR moves in the context of volume clarifies the intensity and participation behind sentiment signals. For example, a sustained high PCR with declining volume suggests diminishing bearish conviction, while a low PCR fading on diminishing call option volume hints at waning bullish momentum. By incorporating volume trends, traders can better assess shifts in market sentiment and participation, creating a more robust indicator for decision-making.

Is the 0.7 Put-Call Ratio Considered a Reasonable Basis for Evaluating Sentiment?

No, relying on the 0.7 put-call ratio level as a definitive threshold for evaluating overall market sentiment is not considered a reasonable basis. While a PCR reading below 0.7 may suggest bullish sentiment, using a static PCR level as the sole criterion for sentiment evaluation or trading decisions is not advisable. The put-call ratio is subject to dynamic fluctuations influenced by various factors, and sentiment extremes typically manifest at levels much lower or higher than 0.7.

The interpretation of a PCR of 0.7 depends on the context, as it can represent neutral sentiment in some cases or complacency if it has sharply declined from higher readings. Instead of fixating on specific PCR values, a more constructive approach involves analyzing the indicator’s trend, momentum, and extremity relative to its own historical data. For instance, evaluating whether the PCR is decreasing from an elevated level, forming a bottoming pattern, or reaching a multi-week/month low provides more actionable insights than isolating it to a single value like 0.7.

Does the Put Option Get the Trader the Right to Sell an Asset at A Preset Price?

Yes, purchasing a put option provides the trader with the right, but not the obligation, to sell the underlying asset at a predetermined strike price before the option’s expiration date. The purpose of a put option is to capitalize on a decline in the asset’s price. By paying a premium when acquiring a put option, the trader gains the rights for a short sale as specified in the put contract. The premium paid represents the maximum potential loss for the trader in this transaction.

Does It Indicate a Bearish Market If the Traders are Buying More Puts than Calls?

Yes, a scenario where traders are buying more put options than call options generally indicates bearish sentiment and a negative outlook for the market. The put-call ratio (PCR) rises in such situations, highlighting increased demand for put options compared to calls. This uptick in the PCR signifies a preference for downside protection or speculation on price decreases. Since put options profit from declining asset prices, an elevated PCR suggests that traders anticipate or hedge against potential market declines.

Is it Right to Use the Call Option to Buy an Asset at a Preset Price?

Yes, buying a call option grants the trader the right, without any obligation, to purchase the underlying asset at a predetermined strike price before the option’s expiration date. The call option enables the trader to profit from an increase in the asset’s price. By paying a premium for the call option, the trader secures the right to a potential long position as outlined in the call contract. This premium represents the maximum loss the trader can incur on the trade. Possessing the call option allows the trader to capture gains if the market price of the asset surpasses the specified strike price. Instead of directly acquiring the asset, the trader can exercise the call option to buy the asset at the predetermined strike level.