Options course · Lesson 2 of 10
Four positions build every strategy.
At expiration, an option is worth its intrinsic value or nothing. That gives four simple shapes. Every strategy in this course combines them.
Value at expiration
At expiration, an option has no time left. It is worth what you get if you exercise it, or nothing. This is its intrinsic value. A call is worth the stock price minus the strike, if that is more than zero. A put is worth the strike minus the stock price, if that is more than zero.
Your profit is that value minus the premium that you paid. For the seller, the profit is the premium minus that value. All figures below are for one contract of 100 shares.
Long call
You pay $331 for the 105 call. If the stock ends at or below $105, the call has no value and you lose the $331. Above $105, each $1 rise adds $100. You break even at $108.31, which is the strike plus the premium.
The loss cannot be more than the premium. The gain has no limit. In the model, the call ends with a profit in 27% of cases.
Long put
You pay $241 for the 95 put. You make a profit if the stock ends below $92.59, which is the strike minus the premium. The largest gain is $9,259, if the stock falls to zero. The model gives a profit in 26% of cases.
Short call and short put
A seller takes the other side. The seller of the 105 call receives $331 and keeps all of it if the stock ends at or below $105. Above $108.31, the seller loses money, and the loss has no limit.
The seller of the 95 put receives $241. The seller loses money below $92.59, and the largest loss is $9,259 at a stock price of zero. Before costs, the profit of the seller is always the loss of the buyer.
| Stock at expiration | Long 105 call | Short 105 call | Long 95 put | Short 95 put |
|---|---|---|---|---|
| $70 | -$331 | +$331 | +$2,259 | -$2,259 |
| $80 | -$331 | +$331 | +$1,259 | -$1,259 |
| $90 | -$331 | +$331 | +$259 | -$259 |
| $95 | -$331 | +$331 | -$241 | +$241 |
| $100 | -$331 | +$331 | -$241 | +$241 |
| $105 | -$331 | +$331 | -$241 | +$241 |
| $110 | +$169 | -$169 | -$241 | +$241 |
| $120 | +$1,169 | -$1,169 | -$241 | +$241 |
| $130 | +$2,169 | -$2,169 | -$241 | +$241 |
The seller wins more often, but not on average
In the model, the short call ends with a profit in 73% of cases, and the long call in only 27%. That does not make the sale a better trade. The seller wins small amounts often, and the buyer wins large amounts less often.
At a fair price, these two effects cancel. The average profit of the long call is +$3, close to zero. The small amount that remains is about the interest on the premium for 90 days.
Key points
- At expiration, an option is worth its intrinsic value or nothing.
- A buyer can lose only the premium. The seller of a call can lose without limit.
- A high chance of profit does not make a trade better. Look at the size of the gains and the losses too.
Sources
- Fischer Black and Myron Scholes, The Pricing of Options and Corporate Liabilities, Journal of Political Economy, 1973, for the model that gives every price in this course.