Call Payoff Diagram

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Call Payoff Diagram발음듣기

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Payoff diagrams are a way of depicting what option or set of options or options combined with other securities are worth at option expiration.발음듣기

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What you do is plot it based on the value on the underlying stock price, and I have two different plots here.발음듣기

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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 people actually trading options.발음듣기

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But they're very similar; this one just worries about the actual value of the options at expirations and this worries about the profit and loss.발음듣기

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So this one will incorporate what you paid for the option, this will not.발음듣기

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This just says what it is worth.발음듣기

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With that said, we have company ABCD trading at $50 per share.발음듣기

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And then we have a call option with a $50 strike price, or $50 exercise price, trading at $10.발음듣기

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Which tells us that the owner of that option has the right but not the obligation to buy Company ABCD stock at $50 per share up to expiration, assuming it's an American option.발음듣기

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If it was a European option, it would be on expiration.발음듣기

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

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So if the stock is worth less than $50, the owner wouldn't execute it.발음듣기

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They wouldn't exercise the option.발음듣기

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So the option would be worthless.발음듣기

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It would be worthless.발음듣기

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They would just let it expire.발음듣기

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No reason to actually exercise the option.발음듣기

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Now, if the underlying stock price is worth more than the $50, if its $51 then you would exercise it,발음듣기

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because now the option is worth $1. You can buy something for $50 and now sell it for $51.발음듣기

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So its now worth $1. If the underlying stock price is $60, of course you would exercise it [as] its now worth $10.발음듣기

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Because you can buy something for $50 and you can immediately sell it at $60.발음듣기

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We're saying that the underlying stock price is $60, so it would be worth $10.발음듣기

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

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Below $50 its worthless, and then above $50 all of a sudden it becomes worth something.발음듣기

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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.발음듣기

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So in this situation below $50 you still would not actually exercise your option because why would you pay $50 for something that is actually trading for less than $50?발음듣기

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But you would say "Hey, I would have had to take a $10 loss because I paid $10 for that option"발음듣기

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So up until $50 your profit is -$10, you have lost $10 dollars, you have lost the price of the option.발음듣기

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Because you wouldn't exercise it.발음듣기

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Then all of a sudden the stock price goes above $50 you would exercise it but you would still have a negative profit because you still haven't made up the price of the option.발음듣기

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All the way up until $60, at $60 per share for the underlying stock price you could exercise the option:발음듣기

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buy the stock at $50, sell it at $60, you would make $10 doing that but of course you had to spend $10 on the option so there you would break even.발음듣기

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But then as you get above a $60 stock price at majority, then all of a sudden you start to make money.발음듣기

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So these are both legitimate payoff diagrams for a call option, for this call option right over here.발음듣기

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They're just different ways of viewing it.발음듣기

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This is the value of the options, this incorporates the actual cost of it.발음듣기

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