Option payoff and Payoff profile Part-2..!!
Continuing from last post Option payoff and Payoff profile Part-1..!! So fair warning this post might be little lengthy, so let’s start without any delay.
Payoff profile for buyer of call option
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. The profit or loss that the buyer makes on the option depends on spot price of the underlying. If upon expiration, the spot price exceeds the strike price, he makes a profit. Higher the spot price, more is the profit he makes. If the spot price of the underlying is less than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option.
Above figure gives the payoff for the buyer of a three month call option (often referred to as long call) with a strike of 2500 bought at a premium of 90. The figure shows the profits/losses for the buyer of a three-month Boltztrade 2500 call option. As can be seen, as the spot Boltztrade rises, the call option is in-the-money. If upon expiration, Boltztrade closes above the strike of 2500, the buyer would exercise his option and profit to the extent of the difference between the Boltztrade -close and the strike price. The profits possible on this option are potentially unlimited. However, if Boltztrade falls below the strike of 2500, he lets the option expire, his losses are limited to the extent of the premium he paid for buying the option.
Payoff profile for writer (seller) of call options: Short call
A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. The profit or loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer’s profit is the seller’s loss. If upon expiration, the spot price exceeds the strike price, the buyer will exercise the option on the writer. Hence as the spot price increases the writer of the option starts making losses. Higher the spot price, more is the loss he makes. If upon expiration, the spot price of the underlying is less than the strike price, the buyer lets his option expire un-exercised and the writer gets to keep the premium.
Above figure gives the payoff for the writer of a three month call option (often referred to as short call) with a strike of 2500 sold at a premium of 90. The figure shows the profits or losses for the seller of a three-month Boltztrade 2500 call option. As the spot Boltztrade rises, the call option is in-the-money and the writer starts making losses. If upon expiration, Boltztrade closes above the strike of 2500, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the Boltztrade close and the strike price. The loss that can be incurred by the writer of the option is potentially unlimited, whereas the maximum profit is limited to the extent of the up-front option premium of Rs.90 charged by him
Payoff profile for buyer of put options: Long put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. The profit or loss that the buyer makes on the option depends on the spot price of the underlying. If upon expiration, the spot price is below the strike price, he makes a profit. Lower the spot price, more is the profit he makes. If the spot price of the underlying is higher than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option
Above figure gives the payoff for the buyer of a three month put option (often referred to as long put) with a strike of 2500 bought at a premium of 90. The figure shows the profits or losses for the buyer of a three-month Boltztrade 2500 put option. As can be seen, as the spot Boltztrade falls, the put option is in-the-money(ITM). If upon expiration, Boltztrade closes below the strike of 2500, the buyer would exercise his option and profit to the extent of the difference between the strike price and Boltztrade close. The profits possible on this option can be as high as the strike price. However, if Boltztrade rises above the strike of 2500, he lets the option expire. His losses are limited to the extent of the premium he paid for buying the option.
Payoff profile for writer (seller) of put options: Short put
A put option gives the buyer the right to sell the underlying asset at the strike price specified in the option. For selling the option, the writer of the option charges a premium. The profit or loss that the buyer makes on the option depends on the spot price of the underlying. Whatever is the buyer’s profit is the seller’s loss. If upon expiration, the spot price happens to be below the strike price, the buyer will exercise the option on the writer. If upon expiration, the spot price of the underlying is more than the strike price, the buyer lets his option un-exercised and the writer gets to keep the premium.
Above figure gives the payoff for the writer of a three month put option (often referred to as short put) with a strike of 2500 sold at a premium of 90. The figure shows the profits or losses for the seller of a three month Boltztrade 2500 put option. As the spot Boltztrade falls, the put option is in-the-money and the writer starts making losses. If upon expiration, Boltztrade closes below the strike of 2500, the buyer would exercise his option on the writer who would suffer a loss to the extent of the difference between the strike price and Boltztrade close. The loss that can be incurred by the writer of the option is a maximum extent of the strike price (Since the worst that can happen is that the asset price can fall to zero) whereas the maximum profit is limited to the extent of the up-front option premium of Rs.90 charged by him.
So these basic six payoff profile will determine the profit for one and loss for another trader, having knowledge of these basic profiles beneficial for trader so that trader can make right decision based on firm knowledge. Hope this post is helpful for traders so that they can make right decision before trading options…Happy Trading!!
Best Wishes!!
