Workshop 3

Practicing With Profit and Loss Diagrams

This workshop will give you added understanding of profit and loss diagrams by taking you step-by-step in making your own diagrams. The basic steps are outlined below.

Start by making a table:

Step 1: Pick a range of stock prices that represent a few strikes above and below the strike price of the option you are drawing. For example, if you are interested in the profit and loss diagram for a $50 call option, you may want to use stock prices of $40, $45, $50, $55 and $60 strikes. That way you are sure to get a clear picture of what will happen to your profits and losses if the stock closes above or below your strike. This is done for you in column 1 in the chart below.

Step 2: Write the values for the option at expiration in column 2 for the various stock prices listed in column 1. Go ahead and type those values in column 2 now (no dollar signs or decimals). Hit the enter key when finished. Remember, a call option will either be worth zero or its intrinsic value at expiration. If the stock price is less than or equal to the strike, the option expires and will be worth zero. If the stock price is higher than the strike price, the option will be worth the intrinsic value, which is the stock price minus the strike price.