The world of options trading has its own language. One of the most important steps to learning about the “language” of trading options involves learning how to calculate options profit. We’ll break down the formula step by step and walk through the differences between calculating options profit for calls and puts.
If you’re new to options trading, we’ll go over the basics of an options contract, the basics of options trades and how to calculate options profit. We’ll also review the MarketBeat options profit calculator tool so you can practice before you execute an option trade.
What is an Options Contract?
An options contract is a financial contract between a buyer and a seller in which the two parties agree to trade an underlying asset (such as shares of a company’s stock) at or before a specified date at an agreed-upon price. This is known as the strike price — the prespecified price that activates the contract.
Because it’s an options contract, the owner of the contract has the right, but not the obligation, to buy or sell an asset at the specified price on or before the specified date. The specific details will vary depending on whether the contract is a call option or put option. Let’s take a look at the definition of both:
- Call option: A call option is a buying action initiated by a trader looking to purchase a call option. This makes the prospective buyer the owner of the option.
- Put option: A put option is a selling action initiated by a trader looking to sell a put option. This makes the prospective seller the owner of the option.
The price of an option contract is also called the “premium.” The party who owns the option (the one who writes the option) can execute their right by buying or selling the underlying security.
An options contract is typically used for hedging and speculation. A standard options contract covers 100 shares. This means that an options contract requires leverage. Leverage increases your buying power so you can buy larger contracts and use less capital.
In addition to stocks, you can also trade options on currency pairs, but this is usually for more experienced traders. MarketBeat provides resources to help you answer questions such as “what is forex?”.
Like stocks, volume matters when it comes to options, but not in the same way. At any point in time, there are multiple options contracts available for call options and put options. When an options contract has excessive call or put volume, it may indicate that a big move may happen. If you’re new to options trading, MarketBeat can help you answer questions such as “what is call option volume” and “what is put option volume”.
The Basics of Options Trades
To better understand options trading and how to calculate options profit, it’s important to understand three terms: strike price, options price and stock price.
- Stock price: The stock price is the most easily understandable. This is simply the price of the stock on the day the option is purchased.
- Strike price: The strike price is the price at which the contract could be executed by the owner of the option. These are standardized prices in fixed increments. For a call option, traders will select a strike price higher than the stock currently trades. Conversely, the owner of a put option will set a strike price lower than the current stock price.
- Option price: The option price is the price per share that the owner pays for the option. This is also known as the option premium and it plays a key role in understanding how to calculate options profit. The options price is set by the market based on the market value of the stock.
Each contract is worth 100 shares. If you buy one contract with an option price of $2, you have $200 at risk. This means you have to ensure that the strike price is sufficiently below (for call options) or above (for put options) that price so you can make a profit.
All three prices occur in the two types of options trades: call options and put options.
Call options are options contracts that give the owner of the contract the right (but not the obligation) to buy a specified amount of shares at the strike price. The owner must exercise their option on or before the expiration date.
As a trader, you purchase call options when you believe that the underlying stock will go up in price. However, because you pay a premium, you must ensure that the options contract will expire “in the money” — at a profit. Later in this article, we’ll provide examples that show you how to calculate call option profit.
Put options can be a little more confusing because they are more counterintuitive. You essentially buy the right to purchase shares at their current price with the expectation that they will be worth less before the contract’s expiration date. If the stock price does fall below the current price and at a price that will leave you “in the money,” you would exercise the option. Your profit is the difference between the two prices (less your premium).
How to Calculate Options Profit
Let’s take a look at the formula to calculate options profit in the next section.
You can calculate the profit on call options with some basic math. First, you’ll need to know several variables. The first is the premium (the price that you’ve paid for the call options). You’ll also have to know the strike price, which is the price at which you can sell the call option. You’ll also need to know how many options are being sold.
You can calculate your total profit by subtracting the premium you paid for the option from the sale price of the stock. The formula looks like this:
(Underlying price - Strike price) - Premium
(4,900-4,500) - 250 = $150
The formula that shows how to calculate option profit looks similar for call and put options. However, with a put option, you’ll subtract the underlying price from the strike price — you’ll want the strike price to be higher.
Terminology in Our Options Calculator
Knowing how to calculate options profit gets easier as you practice. MarketBeat simplifies the process with an interactive tool that makes it easy for newer traders to determine how to structure an options trade. Using it requires you to provide just a few simple inputs.
If you want to trade a specific stock at its current price:
- Enter the ticker for the company that you want to trade. When you enter the symbol in this field, the current stock price automatically shows up in the “stock price” field.
- Select either “call” or “put” option.
- Enter the strike price, option price and number of contracts.
- Click “calculate.”
The field on the right will show you whether your trade is “in the money,” “at the money” or “out of the money” so you can see exactly why your trade might or might not succeed.
If you want to trade a specific stock that is not at your desired price:
- Leave the ticker field blank. This will not affect the calculation.
- Choose either “call” or “put” option.
- Enter the share price, strike price, option price and number of contracts.
- Select “calculate.”
Examples of Calculating Options Profits
To calculate the profit of an options trade, you’ll need to know the current stock price, the strike price, the options price (the premium) and the number of contracts purchased. At that point, the calculator calculates the profit by subtracting the strike price and option price from the current share price and multiplying it by the number of contracts.
Call Option Profit Calculation
Let’s take a look at an example that explains how to calculate call option profit:
Marcie purchases two call options on company ABC’s stock at a current stock price of $30. She believes the stock price will go higher so she selects a strike price on the contract for $33. The cost of each option contract is $2.
If the stock remains at $33 or below, there would be no intrinsic value to the option and Marcie would let it expire. In this case, she would only lose her $400 investment ($2 x 200).
But if the price of company ABC’s stock surges to $36, Marcie would call the option and purchase 200 shares of the stock for $33 (the strike price). Her total investment is now $6,600 (the purchase of the shares plus the premium), not including any commission fees.
In order to profit from her stock purchase, Marcie will sell her 200 shares at market price and receive $7,200. This allows her to pocket a profit of $600 (the market price of her shares minus her $6,600 investment in the contract).
Put Option Profit Calculation
Here’s an example that explains how to calculate put option profit:
Bruce purchases one put option on XYZ company’s stock, which he owns. The current stock price is $40. He believes the stock price will go lower, so he sells 100 shares at the current stock price (at $40). The cost of each option contract is $2.
If the stock stays at or above $40, there would be no intrinsic value to the option and Bruce would let the contract expire. In this case, he would be out $200 ($2 x 100 shares).
However, if company XYZ’s stock price sinks to $33, Bruce would “put” the option on the buyer who would sell those same 100 shares back to Bruce at the strike price of $40 ($4,000). Bruce would then sell the shares at the current price of $33. This would leave him with $700 but after deducting his $200 premium, it would leave him with a $500 profit.
What Happens When Options Expire?
On or after the expiration date, the options contract will expire. This means that the owner of the contract cannot exercise the call or put option and they will be out the cost of the premium (the options price) plus any commissions they may have to pay.
Options traders will allow a contract to expire if it is “out of the money.” This means that it would cost them more to exercise the contract than it would to simply allow it to expire.
Calculate Options Profits with MarketBeat
Although trading options is frequently seen as a more sophisticated trading technique, it’s something that every trader can learn. It can be absolutely essential to trade options in volatile markets where a traditional buy-and-hold strategy may not be profitable.
Options trading can subject you to unnecessary losses and potentially unlimited losses if you short sell options. That’s why it’s important to familiarize yourself with the prices that impact the profit you can make on an options trade.
FAQs
Here are some frequently asked questions about options trading. Some of these were answered in the article, but they are called out here for easy reference. MarketBeat provides other stock trading terms to use.
What is “in the money” in options?
“In the money” refers to a term used to describe an options trade worth more than the price of the option contract if sold on the open market. When an option is “in the money,” a trader will exercise the option.
What is “at the money” in options?
“At the money” describes the break-even point for an options trade. This is the point at which a trader would neither gain nor lose money. If you believe that there is a good chance an option will not do any better than “at the money,” you may exercise the option.
What is “out of the money” in options?
“Out of the money” describes an options trade that would cost the trader more than their options contract. If this is the case, a trader will allow the contract to expire worthless and be out the cost of the options contract (the premium).
How do you calculate profit on an option call?
To calculate the profit of an options trade, you’ll need to know the current stock price, the strike price, the options price (the premium) and the number of contracts purchased. At that point, you can calculate the profit by subtracting the strike price and option price from the current share price and multiplying it by the number of contracts.
