How to Calculate the Gain & Loss of Options
The last post discussed What is an Option. In this post, let's talk about whether options have leverage, what are the risks of options, and what are the characteristics of each of the four directions of options.
Options have leverage, and these are characteristics risks of options:
Buy Call Options
In our last example, Jack spent $0.1million and got the right to buy a house with $5million. If the house price rises to $6million at the expiration, Jack's profit at this time is $6million -$0.1million -$5million = $0.9million, which is equivalent to a profit of 900%. If the house price drops to $4million at the expiration, Jack's loss is $0.1million, and he buys the house at $4million.
Through this example, it is easy to find Jack has no upper limit on his profit, but the maximum loss is $0.1million. Similarly, in options contracts, the biggest loss to buy call options is the premium, no more loss. However, there is no upper limit for profit.
Sell Call Options
There is an agent in this case. The agent said, he could sell the house to Jack at the price of $5million when the contract expired, with $0.08million. So they signed the contract. If the house price rises to $6million when it expires, the agent still sells the house at the price of $5million. Therefore, the income for the agent is $5m+$0.08w-$6m=-0.92m. If the house price rises to $8m, the income of the agent will be $5m+$0.08m-$8m=-$2.92m.
If the house price is lower than $5.08m when it expires, Jack would not execute the options contract. The agent will earn $0.08m as a premium.
Similarly, in options, the agent is the seller of the option. If the stock keeps rising, the loss will expand. In options trading, the contract can be closed before expiration, and it does not need to be held to expiration.
Buy Put Options
The agent is still in this case. If the agent believes that the price of the house will fall later, so he signs a contract with Jack. The agent pays a $0.1m premium and has the right to sell the house to Jack at a price of $4m in the next 6 months.
If the house price is greater than $4.10m when the contract expires, the agent would not execute the contract. The agent will lose $0.1m premium in this case.
If the house falls to $3m when it expires, the agent will exercise the right and sell it to Jack at the price of $4m. The agent would earn $4m-$3m-$0.1m=$0.9m.
Similarly, in options, if you feel there is a high possibility of the stock falling in the future, you can also sell short by buying put options. In this case, the biggest risk is to lose all the premiums.
Sell Put Options
Jack is the person who sold the put option.
If the expiring house price is $4m, Jack still makes a profit of $0.1m. If the house price is $3m when expiring, Jack will lose $4m-$3m-$0.1m=$0.9m
If the house price is $5m when it expires, the agent would not execute the contract, and Jack will have a profit of $0.1m.
These are the 4 common options trades, have you understood them? If you have any questions, please leave a message in the comment area or @OptionsTutor.
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
- ·2022-01-14Thank you. This is the really basic stuff for option calculation. It is really helpful for the beginners!3Report
- T202311701·2022-06-06cool1Report