Call Option Payoff Graph

Call Option Basics

A long call is one of the easiest option trades and a great place for beginners to start their learning journey. A call option is a contract between a buyer and seller. The contract will be for the right to purchase a certain stock at a certain price up until a certain date (called the expiration date).

What this means is that up until the contract expires, the buyer of a call has the right to purchase the stock at the agreed price.

Call Option Payoff Graph

Understanding payoff graphs (or diagrams as they are sometimes referred as) is absolutely essential for option traders. A payoff graph will show the option position’s total profit or loss (Y-axis) depending on the underlying price (x-axis). Here is an example:

What we are looking at here is the payoff graph for a long call option strategy. In this example, the trader has bought a 20 strike call for $2 per contract (or $200 for a standard option contract representing 100 shares). The premium of $200 is the most the trade can lose. That occurs at an underlying stock price of $20 and below. Above the strike price of 20, the line slopes upward as the payoff rises in proportion with the stock price.

The lines crosses into profit at a certain point when the stock price rises above the breakeven point. The breakeven point is simply the strike price plus the premium paid. In this case it would be:

If the premium paid had been slightly higher at $2.20, then the breakeven price would be $22.20

Different Scenarios At Expiration

Four different scenarios can occur at expiration for a long call trade.

  1. The underlying stock price is below the strike price.

If the underlying stock price is below the strike price at expiration, the call option will expire worthless. The loss for the trade will be equal to the premium paid and no more. In our example, this would be $2 per contract, or $200 in total. Think about it this way, if the stock is trading at $18 at expiry, it makes no sense to exercise the option to buy the stock at $20.

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If you’re still having trouble or want to learn more about these concepts, you can check out this 12,000 word ...

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