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Call Option Payoff

PRM Exam I

A call option is the right, but not the obligation, to buy an asset at a prespecified price on, or before, a prespecified date in the future. An investor can take a long or a short position in a call option.

Long Call

Consider a call option with a strike price of $105 and a premium of $3.

This diagram shows the option’s payoff as the underlying price changes for a long call position. If the stock falls below the strike price at expiration, the option expires worthless. The option buyer loses $3 and option seller gains $3. As the stock’s strike price starts increasing above $105, the payoff from the option starts increasing for the buyer. The option will breakeven when the stock price is equal to the strike price plus the option premium ($105 + $3). A call option has unlimited upside potential, but limited downside for the option buyer.

Long Call option

The profit/loss diagram for a long call position is summarized below:

  • Maximum profit is unlimited as theoretically the stock price can keep increasing.
  • Maximum loss is equal to the option premium paid.
  • Breakeven point occurs when the Stock Price = Strike Price + Premium Paid
  • The call option holder will exercise the option when the stock price exceeds the strike price.

Short Call

The following diagram shows the call option payoff from the seller’s perspective.

 Short Call Option

  • The maximum profit is limited to the option premium received.
  • Maximum loss is unlimited. The loss increases as the stock price increases.
  • Breakeven point occurs when the Stock Price = Strike Price + Premium Received

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