Call Options Profit, Loss, Breakeven
The following is the profit/loss graph at expiration for the call option in the example given on the previous page.
The breakeven point is quite easy to calculate for a call option:
- Breakeven Stock Price = Call Option Strike Price + Premium Paid
To illustrate, the trader purchased the $52.50 strike price call option for $0.60. Therefore, $52.50 + $0.60 = $53.10. The trader will breakeven, excluding commissions/slippage, if the stock reaches $53.10 by expiration.
To calculate profits or losses on a call option use the following simple formula:
- Call Option Profit/Loss = Stock Price at Expiration - Breakeven Point
For every dollar the stock price rises once the $53.10 breakeven barrier has been surpassed, there is a dollar for dollar profit for the options contract. So if the stock gains $5.00 to $55.00 by expiration, the owner of the the call option would make $1.90 per share ($55.00 stock price - $53.10 breakeven stock price). So total, the trader would have made $190 ($1.90 x 100 shares/contract).
If the stock price increased by $2.75 to close at $52.75 by expiration, the option trader would lose money. For this example, the trader would have lost $0.35 per contract ($52.75 stock price - $53.10 breakeven stock price). Therefore, the hypothetical trader would have lost $35 (-$0.35 x 100 shares/contract).
To summarize, in this partial loss example, the option trader bought a call option because they thought that the stock was going to rise. The trader was right, the stock did rise by $2.75, however, the trader was not right enough. The stock needed to move higher by at least $3.10 to $53.10 to breakeven or make money.
If the stock did not move higher than the strike price of the option contract by expiration, the option trader would lose their entire premium paid $0.60. Likewise, if the stock moved down, irrelavent by how much it moved downward, then the option trader would still lose the $0.60 paid for the option. In either of those two circumstances, the trader would have lost $60 (-$0.60 x 100 shares/contract).
Again, this is where the limited risk part of option buying comes in: the stock could have dropped 20 points, but the option contract owner would still only lose their premium paid, in this case $0.60.
Buying call options has many positive benefits like defined-risk and leverage, but like everything else, it has its downside, which is explored on the next page.
Next Page - Dangers of Buying Call Options