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Call payoff diagram

A call payoff diagram is a way of visualizing the value of a call option at expiration based on the value of the underlying stock. Learn how to create and interpret call payoff diagrams in this video. Created by Sal Khan.

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  • leaf green style avatar for user Tarek Seif El Nasr
    What is the difference between the call and put options?
    (0 votes)
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  • blobby green style avatar for user Will.H.Ashman
    Surely one would not exercise a call option before expiration, if it was 'in the money', as the time value of the call option would probably be greater than the difference between Stock Price minus Strike Price minus Option Price. So would it be better to sell the option? rather than exercising it?
    (2 votes)
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    • leaf green style avatar for user Ryan
      I think nicole has missed the point of your question though: yes, you can sell the option itself if you think it is at its peak instead of waiting until expiry. This will usually make you more money than exercising the option before expiry (in which case you waste the time-value inherent in the option price), or waiting to exercise at expiry (in which case it may go down).

      So yes, it is generally better to sell the option than to exercise it before expiry.
      (8 votes)
  • blobby green style avatar for user Jimish
    Shouldn't the call option be worthless below 60 ? I mean, If i paid $10 to buy the stock at $50 upto a month later, If i bought it at $50, then i actually paid $10 + $50 = $60. So should the call option give profit above $60 ? Am i missing something ?
    (2 votes)
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  • leaf green style avatar for user Khuong
    A general question about Call Option.
    Doesn't it make more sense for everyone to place a call option at the lowest price possible?
    For example. Let's say I a company trading at $10/share. I placed a call option with $0.01 strike price; so unless the company goes bankrupt, I will guaranteed to make a profit? This would sound too good to be true.
    Is there a limit where you call the strike price at (the current share price or higher?)
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      How much would someone charge you for an option with a strike price of $0.01 when the stock is already at $10? They will charge you at least $9.99, right? And actually they will charge you more than that since the stock could go up. Options are always priced to take into account two components of value: the intrinsic value and the time value. The intrinsic value is how much the option is worth if you exercise it right now. The time value reflects the extra value of being able to wait to exercise.
      (4 votes)
  • orange juice squid orange style avatar for user Varad Kumar
    So how come in the P/L graph we are at a loss of $10 when the strike price is below $50?
    (2 votes)
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    • starky tree style avatar for user melanie
      Because you paid $10 for the option. For example, suppose I pay $2 for an option to buy a stock at $25. I'm out $2 if I don't use that option. I won't use that option at all until the price of the stock goes above $25. So lets say the price of the stock is $26. I use my option, but the stock for $25, then immediately sell it for $26. My profit is:
      Profit=Price I sold stock for - Price of the stock that I paid - Price of the option
      =$26 - $25 - $2
      (2 votes)
  • mr pink red style avatar for user Tomasz Przedmojski
    Shouldn't we consider the time value of money in the P/L diagram? That $10 we have invested could have been earning interest up until the expiration. So our maximum loss should be slightly more than $10. Is my reasoning correct?
    (1 vote)
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  • piceratops sapling style avatar for user spicegirlsxoxop
    i don't get it, is it $10 per stock u pay? i paid $10 to buy the stock at $50 but how much quantity (units) of that stock can i buy with those 10$.

    can i buy 1000 units with that 10$ so wen i sell its (80x1000) - ((50+10)x 1000) = 20k

    0r with that 10$ can i just buy 1 unit this 80- (50+10) = 20$ profit

    and does that $10 depend on the stock price? because i may call a Bekshire Hathaway stock with $10 and because its stock price is very pricey it will fluctuate more in dollar terms.

    thanks, and sorry for a long Q
    (1 vote)
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  • aqualine ultimate style avatar for user Adria Luong
    What is P/L means? Payoff or Price on something?
    (1 vote)
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  • blobby green style avatar for user zachdems97
    When you buy an option you must pay $10. Got that although if you buy options for 100 shares would you need to pay 10$/share or just 10$ per option trade?
    (1 vote)
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  • piceratops sapling style avatar for user Dan
    When you exercise a call option, do you sell the stock right away to realize the profit? If you were planning on holding the stock long term as an investment, wouldn't you just buy the stock immediately, as opposed to buying the call option?
    (1 vote)
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Video transcript

Payoff diagrams are a way of depicting what an option or set of options or options combined with other securities are worth at option expiration. What you do is you plot it based on the value of the underlying stock price. And I have two different plots here, one that you might see more in an academic setting or a textbook, and one that you might see more if you look up payoff diagrams on the internet, or people actually trading options. But they're very similar. This one just worries about the actual value of the options at expiration. This worries about the profit and loss. So this will incorporate what you paid for the option, this will not. This just says what it is worth. So with that said, we have company ABCD trading at 50 dollars per share, and then we have a call option with a $50 strike price or a $50 exercise price trading at $10. Which tells us that the owner of that option has the right but not the obligation to buy company ABCD stock at $50 per share up to expiration, assuming it's an American option. If it was a European option, it would be on expiration. So what is the value of this option at expiration? So this is value at expiration. So if the stock is worth less than $50, the owner wouldn't execute it, they wouldn't exercise the option. So the option would be worthless. It would be worthless. They would just let it expire. No reason to actually exercise the option. Now, if the underlying stock price is worth more than $50, if it's $51, then you would exercise it, because it's now-- the option is worth $1. You can buy something for $50 and sell it for $51, so it's now worth $1. If the underlying stock price is $60, of course, you would exercise it, it's now worth $10. Because you can buy something for $50, and you can immediately sell it at $60. We're saying that the underlying stock price is $60. So it would be worth $10. And so you have a payoff diagram that looks something like this. It kind of hockey sticks. Below $50, it's worthless, and then above $50, all of a sudden, it becomes worth something. Now, if you do it in the profit and loss model, all you have to do is incorporate what you actually paid for the option. So in this situation, below $50, you still would not actually exercise your option. Because why would you pay $50 for something that's actually trading for less than $50? But you would say, hey, I would have had to take a $10 loss, because I paid $10 for that option. So up until $50, your profit is negative $10. You have lost $10. You have lost the price of the option because you wouldn't exercise it. Then all of a sudden if the stock price goes above $50, you would exercise it, but you would still have a negative profit, because you still haven't made up the price of the option. All the way up until $60. At $60 per share for the underlying stock price, you could exercise the option, buy the stock at $50, sell it at $60. You would make $10 doing that, but, of course, you have to spend $10 on the option. So there you are break even. But then as you get above a $60 stock price at maturity, then all of a sudden you start to make money. So these are both legitimate payoff diagrams for a call option, for this call option right over here. They're just different ways of viewing it. This is the value of the option. This incorporates the actual cost of it.