Options traders employ different trading strategies, but they all have one goal: to make a profit. With the right knowledge and approach, options trading can be highly lucrative. And knowing how to calculate profitability is one of the keys to becoming a self-sufficient trader. It can tip you on the best times to enter and exit positions. This article teaches how to calculate profit on options and maximize your earnings.
Profit in Options Trading
Profit from options trading is the amount of money you make from a successful option trade. There are different ways to gain profit using different options types.
Options traders can be divided into sellers/writers and buyers/holders. Buyers can profit if the underlying asset’s price rises above the strike price. This way, they can buy the assets at a lower price and sell them later to make a profit.
Some buyers, known as put buyers, profit when the price of an asset falls below the strike price. They sell the asset at the strike price and then repurchase it at a lower price.
Put sellers, on the other hand, make a profit when the price of the underlying assets goes above the strike price. In this case, the buyer won’t trade the options, leaving the seller with the premium.
Call seller profit when the price of the underlying assets remains below the striker price. That means the contract expires, and the seller gets to keep the premium.
Buyers can sell their options at any time before the set expiration date. This is a good way to lock in profits or minimize losses. Unlike sellers, buyers generally don’t carry an obligation to buy an options contract. The obligations fall on the options seller.
How to Calculate Options Profits
Profitability is influenced by the strike price, the underlying asset’s price movement, volatility, and the expiration date. You need to consider these factors and use a mathematical formula to calculate options profits. Here’s how you should go about this:
- Determine the option type and asset: Options can be call options or put options. A call option allows you to buy the underlying security, while a put option allows you to sell the security.
- Identify the strike price and expiration date: The predetermined price at which the option can be traded is the strike price. The expiration is when a buyer should exercise a chance before it expires.
- Determine the underlying asset’s current price: The asset’s current price is the market price at the time of calculation. You can obtain this from a trading platform or a financial news source.
- Consider the premium: Premium is the income or cost associated with the sale or purchase of an option.
- Calculate the intrinsic value: The inherent value is the amount a buyer would get if they exercised their option. It’s the difference between the underlying asset’s market value and strike price.
- Calculate the breakeven point: In a call option, the strike price is the price plus the premium. A put option is the difference between the strike price and the premium.
How to Calculate Options Trading Profit
The maximum profit for an options seller is the premium. To calculate the max upside, you’ll just need to consider the trading fees.
As the buyer of an option, your profit will depend on whether you’re working with calls or puts.
Here’s the formula to calculate the potential profit:
Put Options Profit = (Strike Price – Current Market Price) – Options Premium
Call Options Profit = (Current Market Price – Strike Price) – Options Premium
Let’s consider the following hypothetical scenarios to give you a better idea of these formulae.
Call Options Profit
Say company ABC’s stock price per share is currently $40. You think the price at expiration will increase, so you buy three contracts at $44 for a $2 premium. The stock price of company ABC rises to $45 before your calls expire. So, you buy 200 shares for $40 each, totaling $8,000.
So your maximum profit from this trade would be:
($9,000 – $8,000) – $400 = $600
Put Options Profit
Let’s say you think the stock price in Company XYZ, currently valued at $50, will fall. So, you purchase two options contracts at a strike price of $40 for a $2.5 premium – $250 for each contract. The stock price falls to $35 by the expiration date.
Your maximum profit for this trade would be:
($10,000 – $8,750) – $500 = $750
Options trading profits are based on timing, market conditions, and individual trading strategies.
Key Takeaways
Before exercising a contract, it’s important to calculate your potential profits and see if they meet your trading objectives. Knowing how the calculations work can help you become a better trader and view potential returns with a new perspective.
