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## Finance and capital markets

### Course: Finance and capital markets > Unit 9

Lesson 1: Put and call options- American call options
- Basic shorting
- American put options
- Call option as leverage
- Put vs. short and leverage
- Call payoff diagram
- Put payoff diagram
- Put as insurance
- Put-call parity
- Long straddle
- Put writer payoff diagrams
- Call writer payoff diagram
- Arbitrage basics
- Put-call parity arbitrage I
- Put-call parity arbitrage II
- Put-call parity clarification
- Actual option quotes
- Option expiration and price

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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.

## Want to join the conversation?

- What is the difference between the call and put options?(0 votes)
- Call: an option to buy stock at strike price within a month anytime the stock price goes above the strike price.

Put: an option to sell stock at strike price within a month anytime the stock price goes below the strike price.(23 votes)

- 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)
- 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)

- 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)
- If a call option allows you to buy something for $50 that is selling for $60, then it has a value of $10 (on the strike date), regardless of what you might have originally paid for the call option.(6 votes)

- 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)- 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)

- So how come in the P/L graph we are at a loss of $10 when the strike price is below $50?(2 votes)
- 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

=-$1(2 votes)

- 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)
- Yes, but normally options are fairly short term so this doesn't make a big difference, especially when it comes to just understanding the concept.(4 votes)

- 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)- Typically a contract is for 100 shares, but the price is quoted per share. In the examples, the lecturer is assuming contracts of one share.(2 votes)

- What is P/L means? Payoff or Price on something?(1 vote)
- 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)
- 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)
- You don't need to sell the stock immediately. But, in order to see the profit over this period, you would have to.(1 vote)

## 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.