Buyers Vs. Sellers And The Option Profit Loss Graph

The price of an option changes as the price of its underlying stock changes, but the relationship is not one to one. In fact, the ratio of an option price to its stock price continuously changes and can be calculated using option software.

Because the ratio of stock price to option price is not constant, option traders need a tool to project what an option’s price will be if the underlying stock price reaches its target (or reaches a stop-loss price). The Option Profit/Loss Graph is that tool. It shows how much profit or loss a particular option position would be expected to make at any given stock price. Here’s a description of how to set up an option profit/loss graph and use it from the perspective of an option buyer.

In the linked example, the investor was contemplating buying a Call option on SPY, the exchange-traded fund that tracks the S&P 500 index.

In that example SPY had closed the day at $332 per share, and the trader believed that it would go up further in the next few weeks (not a recommendation, just a for-instance).

He saw that there were call options at the $330 strike price that were to expire in fourteen days. Each call option represented the right to buy 100 shares of SPY at $330 at any time in following two weeks. The price of the options at that time was $3.00 per share, or $300 per option contract.

The trader needed to know, if he bought the calls at their $3.00 per share price, how much money he could make if SPY went up, by say $4.00 per share or some other amount.

The option buyer’s P/L graph looked like this:

(Click on image to enlarge)

Using the Option profit loss graph for a buy position.

For the trader to make any money at all if he held the option until expiration, SPY would have to be at a price of at least $333.01 per share at that time. If it were, then the trader’s total investment of $333 per share ($3.00 for the option plus $330 for the stock) would be repaid. If SPY were to go up to a higher price, say $337, then the trader would have a profit of $337 – $333 or $4 per share on a $3 per share investment, all in 2 weeks.

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