• Investing
  • Stock
Round Table Thoughts
  • Economy
  • Editor’s Pick
Home Investing Call Option Payoff
Investing

Call Option Payoff

by April 14, 2023
by April 14, 2023 0 comment
Share
0
FacebookTwitterPinterestWhatsapp

This article was written by Chris Young and was first published on Epsilon Options  (now part of SteadyOptions).
 

Below we’ll build up this payoff diagram – for both long and short call options – by considering the behaviour of a call option price at expiry with respect to its strike price.

 

Long Call Option Payoff

Let’s consider the simplest example: a long call option with, say, a strike price of 100 which expires in 3 months time. Suppose also that the stock price is at 90 at present. We hope that the stock will rise above 100 at expiry enabling us to exercise or sell the call as it will have value.

 

To purchase the call, an option premium must be paid which, all things being equal (especially implied volatility), depends on the time to expiry: 3 month in this case. Let’s say that this premium is 10.

 

At expiry one of these scenarios will occur:

 

The stock price is below the 100 exercise price (ie the option is out of the money)

In this case the trade has not worked as planned and the call option will expire worthless. The profit/loss is therefore:

Premium Paid: -$10

Profit from call option: $0

Loss on trade: -10
 

The stock price is between 100 and 110

The call option is in the money which is good news. Its value will be its extrinsic value – the stock price less the strike price – as there is no intrinsic value (option value from time remaining on the option).

 

However this amount will be small – between 0 and 10 – and higher the closer to 110 the stock price is.

 

However it will not be enough to recoup the 10 paid for the call option premium and hence a loss is still made.

 

Our profit/loss – assuming, say, a stock price of $105 is below:

Premium Paid: -$10

Profit from call option: $5

Loss on trade: -5

 

The stock price is 110

This is the option’s breakeven point.

 

At 110 the option will be worth $10 at expiry, recouping all the $10 option premium paid.

 

No profit or loss is made; the trader will break even:

Premium Paid: -$10

Profit from call option: $10

Profit/Loss on trade: $0

 

The stock price is over 110

This is where the trader starts to make a profit.

 

The expired option is now worth more than $10, thus more than recouping the $10 option paid.

 

So if, say, the stock price is 115:

Premium Paid: -$10

Profit from call option: $15

Profit/Loss on trade: $5

This profit will be larger the further the stock price is from the 110 strike price. It is potentially infinite (as the potential stock price is infinite, although this is unlikely).

 

Putting all this together for all possible stock prices gives the following payoff graph:

The horizontal x-axis is the stock price at expiry.

 

Short Call Option Payoff

What if the trader had sold the call option rather than bought it, hoping that the stock would not rise above 100 and hence keep the 10 premium with no cost.

 

Let’s look at the scenarios again:

 

The stock price is below the 100 exercise price (ie the option is out of the money)

In this case the trade has worked as planned and the call option will expire worthless. The profit/loss is therefore:

Premium Received: $10

Loss from call option: $0

Profit on trade: $10
 

The stock price is between 100 and 110

The call option is in the money which is bad news. Its value will be its extrinsic value – the stock price less the strike price – as there is no intrinsic value (option value from time remaining on the option).

 

However this amount will be small – between 0 and 10 – and higher the closer to 110 the stock price is.

 

However it will not be enough to extinguish all the 10 call option premium received and hence a profit is still made.

 

Our profit/loss – assuming, say, a stock price of $105 is below:

Premium Received: $10

Loss from call option: -$5

Profit on trade: $5


The stock price is 110

This is the option’s breakeven point.

 

At 110 the option will be worth $10 at expiry, removing all the $10 option premium received.

 

No profit or loss is made; the trader will break even:

Premium Received: $10

Loss from call option: -$10

Profit/Loss on trade: 0
 

The stock price is over 110

This is where the trader starts to make a (potentially infinite) loss.

 

The expired option is now worth more than $10, thus more than recouping the $10 option paid.

 

So if, say, the stock price is 115:

Premium Received: $10

Loss from call option: -$15

Loss on trade: $5

Breakeven Point Calculation

As we have seen the breakeven point of either a long or short call option position is the expiry price at which neither a profit nor loss is made.

 

It can be calculated using the formula:

 

Conclusion

A call option payoff is a function of the underlying stock’s price at expiration.

For a long/short position, a profit is made if this price is higher/lower than the breakeven point, calculated as the sum of the strike price and the option premium paid/received.

 

You Might Also Like
  • Starbucks stock lacks a meaningful upside from here: Jefferies
  • Oil closes at 2022 low, so why are oil stocks still rising?
  • Is There Such A Thing As Risk-Management Within Crypto Trading?
  • Best FTSE 100 dividend aristocrats for 2023
Share
0
FacebookTwitterPinterestWhatsapp

previous post
Overbought until it Turns – Using the McClellan Oscillator for Condition and the PPO for Timing
next post
Whatever Floats Your Boat

You may also like

XPeng stock rises 48% from a double-bottom pattern. Should you...

December 1, 2022

Argentina win World Cup but ARG token falls 50%

December 19, 2022

Volatility Skewness | IV Skew In Options

April 13, 2023

This retail stock is ‘safe haven’ for recession: Piper Sandler’s...

December 23, 2022

Options Trading Strategy: Bull Call Spread

May 9, 2023

Don’t fight US stocks during the Thanksgiving week

November 25, 2022

Duck Creek stock opened 50% up on Monday: here’s why

January 9, 2023

WisdomTree unveils nine new blockchain-enabled funds

December 14, 2022

What Is An Implied Volatility Crush

January 16, 2023

Options Trading Strategy: Bear Put Spread

May 12, 2023

    Stay updated with the latest news, exclusive offers, and special promotions. Sign up now and be the first to know! As a member, you'll receive curated content, insider tips, and invitations to exclusive events. Don't miss out on being part of something special.


    By opting in you agree to receive emails from us and our affiliates. Your information is secure and your privacy is protected.

    Recent Posts

    • Week Ahead: NIFTY Stays In A Defined Range; Moving Past This Level Crucial For Resumption Of Upmove

      May 31, 2025
    • Breakouts, Momentum & Moving Averages: 10 Must-See Stock Charts Right Now

      May 31, 2025
    • Leadership Rotation Could Confirm Corrective Phase

      May 30, 2025
    • Run Your Stock Portfolio Like a Pro Sports Team

      May 30, 2025
    • U.S. foreign tax bill sends jitters across Wall Street

      May 30, 2025

    Popular Posts

    • 1

      Trump-era China sanctions ended by Biden may be...

      June 27, 2024 2,765 views
    • 2

      Walz’s honeymoon with China gets fresh scrutiny as...

      August 9, 2024 2,472 views
    • 3

      Biden appointee played key role in recruiting Chinese...

      June 25, 2024 2,451 views
    • 4

      Shein’s global ambitions leaves some cybersecurity experts fearful...

      July 10, 2024 2,432 views
    • 5

      Harris VP pick spent years promoting research facility...

      August 29, 2024 2,308 views

    Categories

    • Economy (7,009)
    • Editor's Pick (2,106)
    • Investing (538)
    • Stock (2,582)

    Popular Posts

    • 1

      Trump-era China sanctions ended by Biden may be revived under new House GOP bill

      June 27, 2024
    • 2

      Walz’s honeymoon with China gets fresh scrutiny as Harris camp blasts ‘lying’ critics

      August 9, 2024
    • 3

      Biden appointee played key role in recruiting Chinese businesses to Delaware: ‘Longtime friends’

      June 25, 2024
    • 4

      Shein’s global ambitions leaves some cybersecurity experts fearful of Chinese spy threats

      July 10, 2024
    • 5

      Harris VP pick spent years promoting research facility that collaborated with ‘Chinese military company’

      August 29, 2024

    Latest News

    • Week Ahead: NIFTY Stays In A Defined Range; Moving Past...

      May 31, 2025
    • Breakouts, Momentum & Moving Averages: 10 Must-See Stock Charts Right...

      May 31, 2025
    • Leadership Rotation Could Confirm Corrective Phase

      May 30, 2025

    Categories

    • Economy (7,009)
    • Editor's Pick (2,106)
    • Investing (538)
    • Stock (2,582)

    Disclaimer: RoundTableThoughts.com, its managers, its employees, and assigns (collectively “The Company”) do not make any guarantee or warranty about what is advertised above. Information provided by this website is for research purposes only and should not be considered as personalized financial advice. The Company is not affiliated with, nor does it receive compensation from, any specific security. The Company is not registered or licensed by any governing body in any jurisdiction to give investing advice or provide investment recommendation. Any investments recommended here should be taken into consideration only after consulting with your investment advisor and after reviewing the prospectus or financial statements of the company.

    Copyright © 2024 RoundTableThoughts.com. All Rights Reserved.

    Round Table Thoughts
    • Investing
    • Stock
    Round Table Thoughts
    • Economy
    • Editor’s Pick

    Read alsox

    Tesla shares are now down 72%...

    December 28, 2022

    ECB Governing Council Member Klaas Knots:...

    November 28, 2022

    Apple stock claims a near 2-year...

    December 28, 2022
    Sign In

    Keep me signed in until I sign out

    Forgot your password?

    Password Recovery

    A new password will be emailed to you.

    Have received a new password? Login here