How to Calculate Call Option Payoffs (Profit/Loss)
Call option payoff refers to the profit or loss that an option buyer or seller makes from a trade. Remember that there are three key variables to consider when evaluating call options: strike price, expiration date, and premium. These variables calculate payoffs generated from call options. There are two cases of call option payoffs.
Calculate Call Option Payoffs:
1. Payoffs for Call Option Buyers
Suppose you purchase a call option for company ABC for a premium of $2. The option’s strike price is $50, and it has an expiration date of Nov. 30. You will break even on your investment if ABC’s stock price reaches $52—meaning the sum of the premium paid plus the stock’s purchase price. Any increase above that amount is considered a profit. Thus, the payoff when ABC’s share price increases in value is unlimited.
What happens when ABC’s share price declines below $50 by Nov. 30? Since your options contract is a right, and not an obligation, to purchase ABC shares, you can choose to not exercise it, meaning you will not buy ABC’s shares. Your losses, in this case, will be limited to the premium you paid for the option.
Payoff = spot price – strike price
Profit = payoff – premium paid
Using the formula above, your profit is $3 if ABC’s spot price is $55 on Nov. 30.
2. Payoff for Call Option Sellers
The payoff calculations for the seller for a call option are not very different. If you sell an ABC options contract with the same strike price and expiration date, you stand to gain only if the price declines. Depending on whether your call is covered or naked, your losses could be limited or unlimited. The latter case occurs when you are forced to purchase the underlying stock at spot prices (or, perhaps, even more) if the options buyer exercises the contract. Your sole source of income (and profits) in this case is limited to the premium you collect on expiration of the options contract.
The formulas for calculating payoffs and profits are as follows:
Payoff = spot price – strike price
Profit = payoff + premium
Using the formula above, your income is $1 if ABC’s spot price is $47 on Nov. 30.
ALSO READ: Futures and Options (F&O) – A Beginner’s Guide with Example
There are several factors to keep in mind when it comes to selling call options. Be sure you fully understand an option contract’s value and profitability when considering a trade, or else you risk the stock rallying too high.
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