Option payout. Call payoff diagram

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Forward and futures contracts Video transcript Payoff diagrams are a way of depicting what an option or set of options or options combined with other securities are worth at option expiration. What you do is you plot it based on the value of the underlying stock price.

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. 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.

And I have two different plots here, one that you might see more in an academic setting or a textbook, and one that you might see more if you look up payoff diagrams on the internet, or people actually trading options.

But they're very similar.

Options allow for potential profit during both volatile times, and when the market is quiet or less volatile. When you sell an option, the most you can profit is the price of the premium collected, but often there is unlimited downside potential.

This one just worries about the actual value of the options at expiration. This worries about the profit and loss. So this will incorporate what you paid for the option, this will not.

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This just says what it is worth. If it was a European option, it would be on expiration.

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So what is the value of this option at expiration? So this is value at expiration.

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So the option would be worthless. It would be worthless.

Put and call options

They would just let it expire. No reason to actually exercise the option.

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And so you have a payoff diagram that looks something like this. It kind of hockey sticks.

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Now, if you do it in the profit and loss model, all you have to do is incorporate what you actually paid for the option. Option payout have lost the price of the option because you wouldn't exercise it. So there you are break even.

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So these are both legitimate payoff diagrams for a call option, for this call option right over here. They're just different ways of viewing it.

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Option payout is the value of the option. This incorporates the actual cost of it.