Put Options Profit, Loss, Breakeven
The following is the profit/loss graph at expiration for the put option in the example given on the previous page.
The breakeven point is quite easy to calculate for a put option:
- Breakeven Stock Price = Put Option Strike Price - Premium Paid
To illustrate, the trader purchased the $47.50 strike price put option for $0.44. Therefore, $47.50 - $0.44 = $47.06. The trader will breakeven, excluding commissions/slippage, if the stock falls to $47.06 by expiration.
To calculate profits or losses on a put option use the following simple formula:
- Put Option Profit/Loss = Breakeven Point - Stock Price at Expiration
For every dollar the stock price falls once the $47.06 breakeven barrier has been surpassed, there is a dollar for dollar profit for the options contract. So if the stock falls $5.00 to $45.00 by expiration, the owner of the the put option would make $2.06 per share ($47.06 breakeven stock price - $45.00 stock price at expiration). So total, the trader would have made $206 ($2.06 x 100 shares/contract).
If the stock price decreased by $2.75 to close at $47.25 by expiration, the option trader would lose money. For this example, the trader would have lost $0.19 per contract ($47.06 breakeven stock price - $47.25 stock price). Therefore, the hypothetical trader would have lost $19 (-$0.19 x 100 shares/contract).
To summarize, in this partial loss example, the option trader bought a put option because they thought that the stock was going to fall. By all accounts, the trader was right, the stock did fall by $2.75, however, the trader was not right enough. The stock needed to move lower by at least $2.94 to $47.06 to breakeven.
If the stock did not move lower than the strike price of the put option contract by expiration, the option trader would lose their entire premium paid $0.44. Likewise, if the stock moved up, irrelavent by how much it moved upward, then the option trader would still lose the $0.44 paid for the option. In either of those two circumstances, the trader would have lost $44 (-$0.44 x 100 shares/contract).
Again, this is where the limited risk part of option buying comes in: the stock could have risen 20 points, potentially blowing out a trader shorting the stock, but the option contract owner would still only lose their premium paid, in this case $0.44.
Buying put 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 - Downside of Buying Put Options