Call and Put payoffs

Start your option trading education here

This mini-game will teach you the most fundamental facts about options trading. The payoff profile for a call or a put option at expiration is the most basic attribute of an option and it is the starting point for any option trader’s education.

Let’s go straight into an example from the mini-game.

CALL AND PUT PAYOFFS

Call or Put:                   Put
Bought or sold:             Sold
Traded price:                0.36
Spot:                           138.48
Strike:                         135

Our task is to calculate the profit and loss from this trade at expiration. With practise, you should be able to make this calculation in your head or with a calculator in a just a few seconds.

Firstly, what was the trade? We sold the 135 strike puts at a price of $0.36. At expiration, the spot is trading 138.48. This is above the strike of the puts, so the puts have finished out-of-the-money. Therefore these puts have expired worthless. This is good news, because we sold the puts at 36 cents. So we have the answer. This trade makes a profit of $0.36.

Let’s look at a second example.

CALL AND PUT PAYOFFS

Call or Put:                  Call
Bought or sold:            Sold
Traded price:               0.27
Spot:                          76.23
Strike:                         69

Here, we sold the $69 strike calls at $0.27. The options expired with the spot at $76.23. So these calls are in-the-money. Their value is $7.23 ($76.23 – $69). Our loss on these calls is their value less the amount we collected by selling them. In other words, we have lost $6.96 on this trade.

Note that if we had bought the options in these examples instead of sold, our profit and loss is simply the opposite. So with the calls we would have profited from buying them for 27 cents by $6.96. Likewise, if we had bought the puts, paying 36 cents, we would have simply lost of all this premium.

It is essential to master this mini-game if you want to become a successful options trader. Before you can move on to consider the ‘optionality’ of options (i.e. to understand how they behave before they expire), it is vital that you have the fundamentals completely understood. The most basic fact about an option is whether it is in- or out-of-the-money and what this means for its intrinsic value at expiration. Once you understand how an option’s payoff profile will look for different spot prices at expiration, you can start to understand how it will behave in the days and months leading up to expiration. This is a bit like knowing the final destination of an option; understand that and you will have a better sense of the journey the option will take to get there.

Want to learn how to trade options?

Why not start a FREE trial of Volcube and you can play this mini-game and several others. Find out more.

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Volcube : options education technology

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