🎬 Calculating Profit and Loss of an Option

The profit and loss of an option position at expiration is a function of the original premium and the difference in price between the underlying and the strike price of the option.

Suppose you buy the $100 call for $5 in premium. The maximum loss potential for this trade is $5. Let’s look at a few different possible outcomes for the underlying at $110 $104 $99 $94.

Buy a Call

In this case you buy a call at $100, and pay a $5 premium to the seller. We will look at your profit and loss potential using the same underlying prices at option expiration.

In scenario 1, the underlying price at option expiration will be $110. This option is in the money. You exercise the option at $100. With the underlying at $110, this will result in a gain of $10. If you subtract the $5 premium paid for the option, your net profit will be $5.

For scenario 2, the underlying price at option expiration will be $104. Again, this option is still in the money. You exercise this option at $100 and make $4. You paid $5 in premium, so your net will be a loss of $1.

Scenarios 3 and 4 are both out of the money options. In both cases you would not exercise the option. Your net loss has been capped at $5 which is the full premium paid for the option

Sell a Call

Now let’s look at the same group of scenarios but from the seller’s perspective.

In scenario 1, the underlying price at option expiry is $110. This option will be in the money and you would be assigned. You will sell the underlying for $100 creating an instantaneous $10 loss. You collected $5 in premium and lost $10, so your net loss will be $5.

For scenario 2 we see the underlying price at option expiry is $104. This option is also in the money and again you would be assigned. You will sell the underlying at the strike price of $100 and have a loss of $4. Since you collected $5 in premium you will have a net profit of $1.

In scenario 3, the underlying price at option expiry is $99. This option is out of the money and will not be exercised. There will be no loss. Therefore, your $5 collected in premium will become your total profit.

Scenario 4 has the underlying price at $94. the option will be out of the money and will not be exercised. Your final net position will be a profit of $5.

These scenarios show you two views of profit and loss from either side of the same transaction.
There you have it

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