Profit and Returns on Stock Options
About this lesson
In this video, you will learn how profit and loss of options are calculated.
Calls and puts
- A call option gives the right to buy a stock at the strike price (K) until expiration.
- A put option gives the right to sell a stock at the strike price.
The buyer pays a premium for that right.
Payoff and profit at expiration
With S the stock price at expiration:
| Payoff | Profit | |
|---|---|---|
| Call buyer | max(S − K, 0) | Payoff − Premium |
| Put buyer | max(K − S, 0) | Payoff − Premium |
The option seller’s profit is the opposite of the buyer’s.
Example: a call
Strike $100, premium $5.
| Stock price at expiration | Payoff | Profit | Return on the $5 |
|---|---|---|---|
| $90 | $0 | −$5 | −100% |
| $105 | $5 | $0 | 0% |
| $115 | $15 | $10 | +200% |
The break-even price is strike + premium = $105.
If you’d bought the stock at $100 instead, the move to $115 would have earned 15%. The option earned 200%, but at $90 you’d lose your entire premium, against a 10% loss on the stock. That’s the leverage of options.
Example: a put
Strike $100, premium $4. At $85 the payoff is $15 and the profit $11. The break-even price is strike − premium = $96. Puts gain when the stock falls, so they’re often used as insurance on stocks you own.
Key points
- The most an option buyer can lose is the premium.
- A call seller’s potential loss is unlimited if the stock keeps rising.
- Profits are shown here at expiration; before then, the option’s price also includes time value.
This lesson is for education only and isn’t investment advice.
Next chapter: short selling.