Options Trading Profit Equations

Profit Equations for Options

• Call Option (Buying)

  • Profit = Nc [Max (0, St - X) - C]
  • Intrinsic Value of the option minus the price paid for the option times the number of calls.

• Call Option (Writing)

  • Profit = Max (0, St - X) + C
  • Represents potential earnings from selling the option.

• Put Option (Buying)

  • Profit = Np [Max (0, X - St) - P]
  • Intrinsic Value of the put option minus the price paid for the put times the number of puts.

• Put Option (Writing)

  • Profit = Max (0, X - St) + P
  • Indicates possible profits from writing puts.

Investment Strategies

• Bullish Strategy

  • Involves buying stock, taking a call, or writing a put.
  • Anticipates price increases in the stock market.

• Bearish Strategy

  • Involves shorting a stock, writing a call, or buying a put.
  • Predicts price declines in the stock market.

Covered Call

• Strategy for writers of call options.
• Buy stock while issuing a call to generate premium income.
• If stock is below exercise price (St < X), profit comes from stock price minus cost plus premium.
• If stock is above exercise price (St > X), profit includes exercise price minus cost plus premium.
• Maximum profit = Exercise Price - Cost of Stock + Premium Received; Minimum profit = Cost of Stock + Premium Received.

Protective Put

• A strategy to limit losses when buying stock.
• Involves owning both stock and a put option.
• If stock price is below exercise price (St < X), profit is exercise price minus stock cost minus put premium.
• If stock price is above exercise price (St > X), profit is market price minus stock cost minus put premium.
• Maximum profit is theoretically infinite; Minimum profit = Exercise Price - Stock Cost - Put Premium.

Money Spreads

• Bull Spread

  • Strategy to limit price potential by buying one call and selling another with lower strike price (X1 < X2).
  • Profit = Intrinsic Value from Buying Call - Price Paid + Intrinsic Value from Selling Call + Premium Received.

• Bear Spread Using Calls

  • Strategy anticipating a price drop; buy the call at a higher strike price (X2) and write one at a lower strike price (X1).

• Bear Spread Using Puts

  • Buy a put at strike price X2 and sell a put at lower strike price X1.
  • Maximum profit = X2 - X1 + Premium received (P1) - Premium paid (P2); Minimum profit = P1 - P2.

Straddle

• Combines buying equal numbers of calls and puts to capitalize on expected volatility.
• Maximum profit is limitless; minimum profit is the difference between the premiums of calls and puts.
• Profit realized when the stock price moves significantly in either direction.

Straps and Strips

• Straps

  • Bet on stock price increase; buy two long calls and one long put. Maximum profit is infinite; minimum profit is reduced due to higher call costs.

• Strips

  • Bet on anticipated price decline; buy two long puts and one long call. Maximum profit is infinite; minimum profit accounts for the costs related to the put and call prices.