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    Review of Option Payoffs

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    tfdsg
    The document reviews option payoffs for call and put options. It defines that a call option gives the owner the right to buy the underlying asset at the strike price, while a put option gives the owner the right to sell the underlying asset at the strike price. It then provides the payoff diagrams and formulas for the long and short positions of call and put options, stating that the long position profits when the option is in-the-money, while the short position profits when it is out-of-the-money. It includes an example calculation of the payoff and profit for a long call option.

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    © All Rights Reserved
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    Review of Option Payoffs

    Uploaded by

    tfdsg
    18 views4 pages
    The document reviews option payoffs for call and put options. It defines that a call option gives the owner the right to buy the underlying asset at the strike price, while a put option gives the owner the right to sell the underlying asset at the strike price. It then provides the payoff diagrams and formulas for the long and short positions of call and put options, stating that the long position profits when the option is in-the-money, while the short position profits when it is out-of-the-money. It includes an example calculation of the payoff and profit for a long call option.

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    _ddfc8fac007e7212d31f23cd245c88aa_Review-of-Option-Payoffs

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    The document reviews option payoffs for call and put options. It defines that a call option gives the owner the right to buy the underlying asset at the strike price, while a put option gives the owner the right to sell the underlying asset at the strike price. It then provides the payoff diagrams and formulas for the long and short positions of call and put options, stating that the long position profits when the option is in-the-money, while the short position profits when it is out-of-the-money. It includes an example calculation of the payoff and profit for a long call option.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    18 views4 pages

    Review of Option Payoffs

    Uploaded by

    tfdsg
    The document reviews option payoffs for call and put options. It defines that a call option gives the owner the right to buy the underlying asset at the strike price, while a put option gives the owner the right to sell the underlying asset at the strike price. It then provides the payoff diagrams and formulas for the long and short positions of call and put options, stating that the long position profits when the option is in-the-money, while the short position profits when it is out-of-the-money. It includes an example calculation of the payoff and profit for a long call option.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 4

    Review

    of Option Payoffs

    An option contract gives its owner the right, but not the obligation to buy or sell an
    asset in the future at a price today. A call option gives its owner the right, but not the
    obligation to buy the underlying asset by the expiration or the maturity date at the
    exercise (strike) price. A put option gives its owner the right, but not the obligation
    to sell the underlying by the expiration date at the exercise price.

    If you buy an option, you have the long position and you will exercise your option,
    only if it is profitable to do so – or when the option is in the money. In contrast, the
    party who has written the option contract or sold the option has the short position.
    The option will not be exercised if it does not yield a positive payoff – or when the
    option is out of the money.

    Let’s review the payoffs at expiration to long call and short call positions. Remember
    a call option gives its owner to buy the underlying asset at the exercise price. Let 𝑋
    denote the exercise price of the option and 𝑆! be the market price of the underlying
    asset at the expiration date 𝑇. A call option will be exercised if doing so yields a
    positive payoff to the holder of the option – that is, if 𝑆! > 𝑋 → 𝑆! − 𝑋 > 0.
    Otherwise, if 𝑆! < 𝑋, then the call option will not be exercised and the payoff is zero.

    Payoff to long call position:
    𝑆! − 𝑋 𝑖𝑓 𝑆! > 𝑋
    0 𝑖𝑓 𝑆! < 𝑋

    The short position has the obligation to sell the underlying asset at the exercise
    price if holder of the option chooses to exercise. Therefore the payoff to the short
    call position is given by:
    − 𝑆! − 𝑋 𝑖𝑓 𝑆! > 𝑋
    0 𝑖𝑓 𝑆! < 𝑋

    The profit to long call position takes into account the premium – that is, how much
    the option’s holder paid for the option. Let 𝑃 denote the option premium.

    Profit to long call position:
    𝑆! − 𝑋 − 𝑃 𝑖𝑓 𝑆! > 𝑋
    −𝑃 𝑖𝑓 𝑆! < 𝑋

    Payoff to short call position:
    𝑃 − 𝑆! − 𝑋 𝑖𝑓 𝑆! > 𝑋
    𝑃 𝑖𝑓 𝑆! < 𝑋

    Payoff diagram for a long call position

    Payoff

    ST - X

    In the money (profitable to exercise the option

    ST
    X

    Out of the money (not profitable to exercise the option)

    The payoff diagram for the short call position will be the mirror image of this flipped
    along the x-axis.

    Example
    Suppose that the stock of the company “LFI” is trading on January 16 at a price of $60.
    A call option (each contract size consists of 100 shares) with a strike price of $60 and an
    expiration date on February 15 is trading on January 16 at $4 each share. What is your
    total payoff if the market price of LFI is $70 per share at expiration date? What is your
    profit?

    𝑆! = $70
    𝑋 = $60

    𝑇𝑜𝑡𝑎𝑙 𝑝𝑎𝑦𝑜𝑓𝑓 = 100 × 70 − 60 = $1000

    𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 = 100 × 70 − 60 − 4 = $600


    Let’s now review the payoffs at expiration to long put and short put positions.
    Remember a put option gives its owner to sell the underlying asset at the exercise
    price. Let 𝑋 denote the exercise price of the option and 𝑆! be the market price of the
    underlying asset at the expiration date 𝑇. A put option will be exercised if doing so
    yields a positive payoff to the holder of the option – that is, if 𝑆! < 𝑋 → 𝑋 − 𝑆! > 0.
    Otherwise, if 𝑆! > 𝑋, then the put option will not be exercised and the payoff is zero.

    Payoff to long put position:
    𝑋 − 𝑆! 𝑖𝑓 𝑆! < 𝑋
    0 𝑖𝑓 𝑆! > 𝑋

    The short position has the obligation to buy the underlying asset at the exercise
    price if holder of the option chooses to exercise. Therefore the payoff to the short
    put position is given by:
    − 𝑋 − 𝑆! 𝑖𝑓 𝑆! < 𝑋
    0 𝑖𝑓 𝑆! > 𝑋

    The profit to long put position takes into account the premium – that is, how much
    the option’s holder paid for the option. Let 𝑃 denote the option premium.

    Profit to long put position:
    𝑋 − 𝑆! − 𝑃 𝑖𝑓 𝑆! < 𝑋
    −𝑃 𝑖𝑓 𝑆! > 𝑋

    Payoff to short put position:
    𝑃 − 𝑋 − 𝑆! 𝑖𝑓 𝑆! < 𝑋
    𝑃 𝑖𝑓 𝑆! > 𝑋


    Payoff diagram for a long put position

    Payoff
    In the money (profitable to
    exercise the option
    X- ST





    ST
    X
    Out of the money (not profitable to
    exercise the option


    The payoff diagram for the short put position will be the mirror image of this flipped
    along the x-axis.


    Example
    Suppose that you have a portfolio of 100 shares of the stock of the company “Econ Plus”.
    On January 16, the stock has a trading price of $50. A put option (each contract size
    consists of 100 shares) with a strike price of $50 and an expiration date on February 15 is
    trading at $6 each share. What would your total payoff on the option contract be at
    expiration date if you bought the put option to protect the value of your portfolio and the
    stock price dropped to $30? What would your total profit be?

    𝑆! = $30
    𝑋 = $50

    𝑇𝑜𝑡𝑎𝑙 𝑝𝑎𝑦𝑜𝑓𝑓 = 100 × 50 − 30 = $2000

    𝑇𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡 = 100 × 50 − 30 − 6 = $1400

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