Options Pricing: Profit and Loss Diagrams

5 stars based on 45 reviews

Further we looked at four different variants originating from these 2 options —. Think of it this way — if you give a good artist a color palette and canvas he can create some really interesting paintings, similarly a good trader can use these four option variants to create some really good trades. Imagination and intellect is the only requirement for creating these option trades.

Hence before we get deeper into options, it is important to have a strong foundation on these four variants of options. For this reason, we will quickly summarize what we have learnt so far in this module. Arranging the Payoff diagrams in the above fashion helps us understand a few things better. Let me list them for you —. Going by that, buying a call option and buying a put option is called Long Call and Long Put position respectively.

Going by that, selling a call option and selling a put option is also called Short Call and Short Put position respectively. However I think it is best to put option payoff diagram a few key points before we make further progress in this module.

Buying an option call or put makes sense only when we expect the market to move strongly in a certain direction. If fact, for the put option payoff diagram buyer to be profitable the market should move away from the selected strike price. Selecting the right strike price to trade is a major task; we will learn this at a later stage. For now, here are a few key points that you should remember —.

The put option payoff diagram sellers call or put are also called the option writers. Selling an option makes sense when you expect the market to remain put option payoff diagram or below the strike price in case of calls or above strike price in case of put put option payoff diagram. I want you to appreciate the fact that all else equal, markets are slightly favorable to option sellers. This is because, for the option sellers to be profitable the market has to be either flat or move in a put option payoff diagram direction based put option payoff diagram the type of option.

However for the option buyer to be profitable, the market has to move in a certain direction. Clearly there are two put option payoff diagram market conditions for the option seller versus one favorable condition for the option buyer. But of put option payoff diagram this in itself should not be a reason to sell options.

This means to say that the option writers earn small and steady returns by selling options, but when a disaster happens, they tend to lose a fortune. Well, with this I hope you have developed a strong foundation on how a Call and Put option behaves. Just to give you a heads up, the focus going forward in this module will be on moneyness of an option, premiums, option pricing, option Greeks, and put option payoff diagram selection. Once we understand these topics we will revisit the call and put option all over again.

This information is highlighted in the red box. Below the red box, I have highlighted the price information of the premium. If you notice, the premium of the CE opened at Rs. Moves like this should not surprise you. These are fairly common to expect in the options world. Assume in this massive swing you managed to capture just 2 points while trading this particular option intraday.

This translates to a sweet Rs. In fact this is exactly what happens in the real world. Traders just trade premiums. Hardly any traders hold option contracts until expiry. Most of the traders are interested in initiating a trade now and squaring it off in a short while intraday or maybe for a few days and capturing the movements in the premium. They do not really wait put option payoff diagram the options to expire. These put option payoff diagram are marked in the blue box.

Below this we can notice the OHLC data, which quite obviously is very interesting. The CE premium opened the day at Rs. However assume you were a seller of the call option intraday and you managed to capture just 2 points again, considering the lot size isthe 2 point capture on the premium translates to Rs. However by no means I am suggesting that you need not hold until expiry, in fact I do hold options till expiry in certain cases. Generally speaking option sellers tend to hold contracts till expiry rather than option put option payoff diagram.

This is because if you have written an option for Rs. So having said that the traders prefer to trade just the premiums, you may have a few fundamental questions put option payoff diagram up in your mind.

Why do premiums vary? What is the basis for the change in premium? How can I predict the change in premiums? Who decides what should be the premium price of a particular option? Well, these questions and therefore the answers to these form the crux of option trading. To give you a heads up — the answers to all these questions lies in understanding the 4 forces that simultaneously exerts its influence on options premiums, as put option payoff diagram result of which the premiums vary.

Think of this as a ship sailing in the sea. The speed at which the ship sails assume its equivalent to the option premium depends on various forces such as wind speed, sea water density, sea pressure, and the power of the ship. Some forces tend to increase the speed of the ship, while some tend to decrease the speed of the ship. The ship battles these forces and finally arrives at an optimal sailing speed.

Crudely put, some Option Greeks tends to increase the premium, while some try to reduce the premium. Try and imagine this — the Option Greeks influence the option premium however the Option Greeks itself are controlled by the markets. As the markets change on a minute by minute basis, therefore the Option Greeks change and therefore the option premiums!

Going forward in this module, we will understand each of these forces and its characteristics. We will understand how the force gets influenced by the markets and how the Option Greeks further influences the premium. We will do the same in the next chapter. A quick note here — the topics going forward will get a little complex, although we will try our best to simplify it. While we do that, we would request you to please be thorough with all the concepts we have learnt so far.

Thanks a lot for sharing learning material, it is really helpful for beginners like me to understand the concept and strategy of share market. We are trying out best to complete the modules as fast as we can. European option means the settlement is on expiry day.

However, you can just speculate on option premiums…and by virtue of which, you can hold the position for few mins or days. Also we have potential of unlimited profit in long call or long put and even we can trail stoploss of premiums.

Thank you so much for your articles sir. Cause sitting in front of computer is not possible. Even if we r there we may miss the trade id doing some thing else at the time we are suppose to trade or put option payoff diagram the tyrade.

Till now it has been very clear and crisp. Thanks for that and hope that further chapters will also come the same way. We will be discussing SL based on Volatility very soon. Request you to kindly stay tuned till then. We certainly hope to keep the future chapters as easy and lucid as the previous ones have been. Hi Really nice initiative sir. Hello Sir, if I buy a lot ofcall option of strike price at a premium of Rs 2 with a spot price of Now if the price moves to and premium is now at 3 so would be my profit??

Firstly, if the spot moves from tothe premium of the Call option will certainly be more than Rs. Your profits would be —. Hello Sir, I am still confused with the way the profit is calculated.

Might be, I am not able to get what u explained and I am really sorry for asking it again. In some of your replies, you mentioned that the profit is calculated as per the difference of spot price and strike price and in some replies u mentioned that it is as per the difference of premium.

In case put option payoff diagram 1 lot of shares the profit would be. So which of the above options are correct??? Is there a difference if I am closing my position before expiry or excersize it at expiry? For all practical purposes I would suggest you use the 2nd way of calculating profits…i. Do remember the premium paid for this option is Rs 6.

Irrespective of how the spot value changes, the fact that I have paid Rs. This is the cost that I have incurred in order to buy the Call Option. Please note — the negative sign before the premium paid represents a cash out flow from my trading account.

This put option payoff diagram to my confusion. Got your point, see if you are holding the option till expiry you will end up getting the amount equivalent to the intrensic value of the option.

I have explained more on this in the recent chapter on Theta…but I would suggest you read up sequentially and not really jump directly to Theta. Put option payoff diagram calculation provided by karthik in chapter 3 is for expiry calculation on expirt date. Hope this clears your doubt. The minimum value for this option should be STT stands for Security Transaction Tax, which is levied by the Government whenever a person does any transaction on the exchange.

Saxo bank forex review

  • Donchian channel trading signals dubai

    List of commodities trading in india

  • Uk options phone numbers list

    Us binary option trading tips companies learn how to invest!

Binary option alert software reviews

  • Best cheap online stock trading site for beginners in india

    Binary options buddy 20 free download

  • Binary trading download

    Binary options trading demo system reviews

  • Options strategy for apple iphone in india

    Binary option system volume on disk is corrupt story

Onvista bank optionsscheine

23 comments Options trading stock market investments

Binary option robot binaryoptionrobotcom

If you have seen the page explaining call option payoff , you will find the overall logic is very similar with puts; there are just a few differences which we will point out.

While a call option gives you the right to buy the underlying security, a put option represents the right but not obligation to sell the underlying at the given strike price. When holding a put option, you want the underlying price go down, because the lower it gets relative to the strike price, the more valuable your put option becomes. A long put option position is therefore a bearish trade — makes money when underlying price goes down and loses when it goes up.

You can see the payoff graph below. Of course, it also depends on your position size 1 contract representing shares in this example. The relationships is linear and the slope depends on position size. For example, if underlying price is You can immediately buy it back on the market for Above the strike, the put option has zero value, because there is no point exercising the right to sell the underlying at strike price when you can sell it for a higher price without the option.

The first component is equal to the difference between strike price and underlying price. The lower underlying price gets relative to strike price, the higher your cash gain at expiration. However, this only applies when underlying price is below strike price. When it gets above, the result would be negative you would be losing money by exercising the option. Because a put option gives you the right but not obligation to sell, if underlying price is above strike price, you choose to not exercise the option and therefore cash flow at expiration is zero.

Taking all scenarios into consideration, a long put option cash flow at expiration is therefore the higher of:. The above is per share. To get the total dollar amount, you need to multiply it by number of contracts and contract multiplier number of shares per contract.

Initial cost is of course the same under all scenarios. Therefore the formula for long put option payoff is:. It is very easy to calculate the payoff in Excel. The key part is the MAX function; the rest is basic arithmetics. You can see all the formulas in the screenshot below. Besides the strike price, another important point on the payoff diagram is the break-even point, which is the underlying price where the position turns from losing to profitable or vice-versa.

Calculating the exact break-even price is very useful when evaluating potential option trades. The formula for put option break-even point is actually very simple:. If you don't agree with any part of this Agreement, please leave the website now. All information is for educational purposes only and may be inaccurate, incomplete, outdated or plain wrong. Macroption is not liable for any damages resulting from using the content.

No financial, investment or trading advice is given at any time. Home Calculators Tutorials About Contact. Tutorial 1 Tutorial 2 Tutorial 3 Tutorial 4. Put Option Payoff Diagram and Formula.

This page explains put option payoff. We will look at: Long Put Option Position is Bearish While a call option gives you the right to buy the underlying security, a put option represents the right but not obligation to sell the underlying at the given strike price.

Put Option Payoff Diagram You can see the payoff graph below. Put Option Scenarios and Profit or Loss 1. What you can get when exercising the option What you have paid for the option in the beginning The first component is equal to the difference between strike price and underlying price. Taking all scenarios into consideration, a long put option cash flow at expiration is therefore the higher of: Therefore the formula for long put option payoff is: Put Option Break-Even Point Calculation Besides the strike price, another important point on the payoff diagram is the break-even point, which is the underlying price where the position turns from losing to profitable or vice-versa.

The formula for put option break-even point is actually very simple: Long Put Option Payoff Summary A long put option position is bearish, with limited risk and limited but usually very high potential profit. Maximum possible loss is equal to initial cost of the option and applies for underlying price higher than or equal to the strike price.

With underlying price below the strike, the payoff rises in proportion with underlying price. The position turns profitable at break-even underlying price equal to strike price minus initial option price.

Maximum theoretical profit which would apply if the underlying price dropped to zero is per share equal to the break-even price.