FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.

posted on 12 February 2016

Option Return Charts

by Russ Allen, Online Trading Academy Instructor

Online Trading Academy Article of the Week

When trading options, we have quite a few moving parts to juggle. Fortunately, technology now gives us tools that make this much easier.

One of those tools is the option payoff graph, also called the option return graph, also called the risk graph. We'll take a look at this tool today.

We have been using the stock of General Electric for our examples recently, so let's continue with that. Here's how GE's chart looked on January 27, 2016:

Learn to use the option payoff graph

Let's say we were neutral-to-bullish on GE and expected it to hold or go higher from here in the next few weeks. We might consider the trade that I described last week, which was to sell (short) put options for the February 19, 2016 expiration at the $27 strike price. These could be sold for $.39 per share, or $39.00 per 100-share option contract.

To view the profit and loss possibilities of an option position, there is a standard format for portraying them graphically. The option payoff graph for this short put trade looks like this:

See the profit and loss potential of an option position using the option payoff graph

The gray line on this graph relates the stock price at the option expiration date to the amount of profit or loss that the option position would make with the stock at that price. The system "knows" that we would receive $39 when we sold the puts to enter the position.

These graphs take a little getting used to for those of us accustomed to using stock price charts. Note these points about the payoff graph:

  1. The price of the stock runs left to right (on the X or horizontal axis), not up and down on the Y or vertical axis, as price charts do.

  2. The vertical axis is profit or loss on the position at the indicated stock price.

  3. Not shown but, built into the graph is the amount of money paid out or taken in to open the position. In our example, we sold puts for $39.00 for the contract.

  4. No time or movement is shown on the graph. The gray line is drawn as of a specific instant in time - the moment of option expiration, 23 days in the future. It shows what the amount of profit or loss would be if the stock were to be at the indicated price at that time.

In this case, the gray line slopes upward from left to right and then levels out at a profit of $39.00. This indicates that the maximum profit on the trade is $39.00 and that this would be the result if the stock were to be at any price at or above $27.00 at expiration. The gold arrows point to the amount of profit ($39.00) and to the corresponding stock price ($27.00).

This makes sense when we remember that the puts will be worthless when they expire unless the stock is below their strike price of $27.00. If they are worthless then we will not have to pay anything to buy them back and terminate the trade, and we will keep the $39.00 we received for them. This will be our profit.

The black arrows point to the zero point on the P/L axis and to the corresponding stock price of $26.61. This indicates that if at expiration the stock is at $26.61, our trade will break even. In that case the puts would be worth $.39 per share. They convey the right to their holders to force us to buy the stock and pay $27.00 (their strike price), which would certainly happen. Since $27.00 would be $.39 higher that the stock value at that point, we would have a loss at that time of $.39 per share. This would exactly absorb our original credit of $.39 per share, for no net gain or loss.

At stock prices between $26.61 and $27.00 our position shows positive values for profit of more than zero and less than the maximum profit of $39.00.

And at stock prices below the $26.61 break-even price the position would show a loss.

There is quite a bit more that the option payoff graph can tell us. Next time we'll continue with that.

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical Investing Post Listing

Make a Comment

Econintersect wants your comments, data and opinion on the articles posted.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.

You can also comment using Facebook directly using he comment block below.

Econintersect Investing


Print this page or create a PDF file of this page
Print Friendly and PDF

The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.

Take a look at what is going on inside of
Main Home
Analysis Blog
Taking a Wrench to Healthcare
Rising Tide Does Not Lift All Ships
News Blog
September 2016 CFNAI Super Index Moving Average Declines
Consequences Of Rising Income Inequality
America's Most Competitive Renters: Why Many Are Choosing To Rent
Historical Echoes: The Bank Teller Action Figure, Or It's All In The Packaging
Infographic Of The Day: The Oil Market Is Bigger Than All Metal Markets Combined
U.S. 2016 Election Divides Advanced And Emerging Economies
Which Countries Read The Most
The World's Most Expensive Retail Locations
How To Help Energy Demand Match Renewable Supply
Music Subscriptions Revive Revenue
How The Space Station Avoids Junk In Space
Infographic Of The Day: The Most Popular Jobs In A Decade
Early And Late Cycle Verdicts Are Baseless
Investing Blog
FinTech Is Taking A Bite Out Of Banks
Options Early Assignment - Should You Worry?
Opinion Blog
The Beer Goggles Stock Market
US 2016 Election: Will US-China Relations Change
Precious Metals Blog
Preparing For Post-Election Social Unrest
Live Markets
24Oct2016 Pre-Market Commentary: Wall Street Moves Higher Ahead Of Corporate Earnings And Friday's GDP Report, Texas Tea Slips Lower, US Dollar Not As Strong As Friday, Gold Skyrockets Upwards
Amazon Books & More

.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Middle East / Africa
USA Government

Crowdfunding ....



Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved