Explain the option
Describe an option position in plain words. Set side, type, strike, expiry and premium, add a stock leg if you hold one, and read off the strategy, max gain and loss, break-even and P&L at expiry.
Max gain, max loss and break-even for each position
At expiry an option is worth its intrinsic value: max(S − K, 0) for a call and max(K − S, 0) for a put, where S is the stock price and K the strike. Subtract the premium paid, or add the premium received, and multiply by 100 shares per contract to get the P&L. P is the premium per share below.
| Position | Max gain | Max loss | Break-even |
|---|---|---|---|
| Long call | Unlimited | P × 100 | K + P |
| Long put | (K − P) × 100, if the stock goes to 0 | P × 100 | K − P |
| Short (naked) call | P × 100 | Unlimited | K + P |
| Short (naked) put | P × 100 | (K − P) × 100, if the stock goes to 0 | K − P |
With 100 shares: covered and protective positions
Holding the stock changes the risk completely. S₀ is the price the shares were bought or sold short at.
| Position | Max gain | Max loss | Break-even |
|---|---|---|---|
| Covered call: long shares + short call | (K − S₀ + P) × 100 | (S₀ − P) × 100 | S₀ − P |
| Protective put: long shares + long put | Unlimited | (S₀ − K + P) × 100 | S₀ + P |
| Covered put: short shares + short put | (S₀ − K + P) × 100 | Unlimited | S₀ + P |
| Protective call: short shares + long call | (S₀ − P) × 100 | (K − S₀ + P) × 100 | S₀ − P |
A covered call keeps the stock's downside and caps the upside at the strike. A protective put keeps the upside and puts a floor under the loss. If the shares and the option point the same way, for example long shares plus a long call, nothing is covered: it is a leveraged bet in one direction.
Worked example: a short put
You sell one ABC 100 put for 3.50. You collect $350 up front, and if assigned you must buy 100 ABC shares at 100.
- Max gain: $350, if ABC is at or above 100 at expiry.
- Break-even: 100 − 3.50 = 96.50.
- Max loss: (100 − 3.50) × 100 = $9,650, if ABC goes to 0.
- ABC at 95 at expiry: the put is worth 5.00, so the P&L is (3.50 − 5.00) × 100 = −$150.
These are values at expiry. They leave out commissions, and US equity options can be assigned early, before expiry.