In the fantastic put or call option calculator, you can determine how much profit/loss you can make if you are the owner (buyer) of an option contract and execute it before expiration. In this article, we will cover the methodology for a call option profit calculation. Additionally, we will review how to calculate a put option profit and discuss a real-life example about when to sell an option contract.
What is an option contract?
An option contract is a derivative, meaning that its value is derived from the value of another asset; for example, stocks, commodities, or market index ETFs. It is important to mention that the asset from which the option contract derives its value is known as the underlying asset.
Traders (not necessarily investors) use option contracts to speculate about future asset's price movement. You have two option contracts class: a call option and a put option.
A call option gives the owner, i.e., the one who bought the option contract, the right (but not the obligation!) to buy a stock at a predetermined price (see What is the strike price? in the FAQ section), over a given period of time, regardless of the current market price of the stock.
As you can see, the utility of a call option for the buyer is that it can get shares of a stock for a reduced price compared to the market and then sell the call option for profits. This way of action implies a bullish view of the asset (you expect the asset price to increase). The buyer is considered to be long in the call option.
In that sense, our call option calculator can also be named a long call option calculator.
A put option gives the owner, i.e., the one who bought the option contract, the right (but not the obligation) to sell at a predetermined price over a given period of time, regardless of the current market price of the stock.
Contrarily to the long call option strategy, in the put option, you expect the price to fall below the agreed fixed price so you can sell the shares at this price and cover yourself in case the market stock price keeps falling. In other words, you would be able to sell your shares at a higher price than the current stock market price if you are long in the put option.
Similarly, our put option calculator can also be named a long put option calculator.
Terminology in our put call option calculator: Strike price and others
Before we explore how to calculate call options profit, we must review the terminology used in an option contract. We will explain what each variable means in our put call option calculator and what it means to be "in the money," "at the money," and "out of the money" in the call vs. put option scenarios.
Call option calculator
Current price and target price: These are the underlying asset prices from which the call option derives its value. You can use our call option calculator to see the profits considering the current underlying asset price in the market, or you can calculate your possible profits if you have a target price in mind.
Strike price of a call option: The strike price definition refers to the predetermined asset price, let's say stock, at which, if the market price of the underlying stock goes over the agreed price, the call option can be executed.
In other words, the call owner has the right (but not the obligation) to buy the underlying asset shares from the option writer at the strike price, regardless of the current market price. Then the new owner of the shares could sell them for a profit if they want. If the current price is above the strike price, we say the call option is in the money.
Price of the call option: Option contracts have their own price/cost, which changes accordingly to market dynamics such as market positive or negative expectations, remaining time to contract option expiration, etc.
Amount of options contracts: Refers to how many contracts you are going to buy. Remember that each contract represents 100 call options. That means that if you buy four call option contracts, you get the right over 400 call options; thus, 400 shares of the underlying asset.
Total call options cost (the premium): Represents the total investment you will make for getting your desired amount of option contracts. This amount is also known as your capital at risk. If the stock's current price is below the strike price, we say your option contract is out of the money.
Call potential profit: Refers to the profit you could make for the operation minus call option costs, expressed in percentage.
Call potential return: Refers to the profit you could make for the operation minus call option costs, expressed in your currency. Note that even if the underlying asset's current price is equal to the strike price, you will incur a loss due to call option costs. When both stock price and strike price are the same, we say the call option is at the money.
Put option calculator
Strike price of a put option: The strike price definition is the same here but for a different purpose. When the underlying asset price goes below the strike price, the owner of the put option may sell the shares to the counterparty at the strike price, regardless of the stock's current market price. For put options, when the current price is below the strike price, we say your contract is in the money. Precisely the opposite of the call option.
Price of the put option: Similarly to a call, this is the price for obtaining one single put option contract. The relation between put price and call price is explained by the put call parity equation.
Total put option cost (the premium): The total cost you will pay for obtaining the amount of desired put contracts.
Put potential profit: When the underlying asset price goes below the strike price, and the put option is in the money, your operation is not necessarily profitable because the potential gains if the contract is executed could be offset by the put costs.
Put potential return: Refers to the profits you would make by selling the stock at the strike price when the market stock price is below. Note that if the stock's current price is above the strike price, we call it: out of the money, because we cannot execute the contract. When the strike price and current stock price are the same, we call it: at the money.
Call vs. put option – Advice for investors
Here we are going to spend some time suggesting scenarios where you could use a long call option and a long put option:
Long call option strategy: Here, you profit if the underlying asset price goes over the strike price. In the case of investing in a company, you should look for high revenue growth, high operating cash flow growth, and high earnings per share (EPS) growth.
Besides, consider tracking the moving average. If your stock price is over its moving average, you are in an excellent way to make money.
Long put option strategy: Here, you profit if the underlying asset price goes below the strike price. A company with a decreasing interest coverage ratio or a high debt to equity ratio may be prone to bankruptcy; thus, its share price could fall and make you earn profits.
Furthermore, the market could crash in a highly leveraged environment if interest rates increase. Consequently, you could protect (hedge) your portfolio by buying whole-market ETF puts. Then when the market ETF price is below the strike price, you sell the put option making profits.
Example of a call option profit calculation
We are going to cover the formulas and an example at the same time:
The following call for AMD stock has a strike price of 70 USD and a call option price of 7.50 USD. Imagine you are bullish on the stock, and you've seen that the cash conversion cycle has improved, so you want to take extra gains of a very likely stock run.
Let's see how to calculate the call option profit when the target price is 82.40 USD and the desired number of contracts is 4. Our data looks like this:
Target price (TP) = 82.4 USD
Strike price (SP) = 70 USD
Price of the call option (PCO) = 7.5 USD
Number of option contracts (n) = 4, remembering that each contract contains 100 options.
Then, the results are as follows:
Total option cost = PCO * n * 100
Total option cost = 7.5 USD * 4 * 100 = 3000 USD
Call potential profit = (TP - SP - PCO) / PCO
Call potential profit = ((82.4 USD - 70 USD - 7.5 USD) / 7.5 USD) * 100% = 65.32 %
Call potential return = (TP - SP - PCO) * n * 100
Call potential return = (82.4 USD - 70 USD - 7.5 USD) * 400 = 1960 USD
You can also play with the variables of this example in our long call option calculator to see how the option price or strike price affects the profits.
Example of a long put option profit calculation
Now we are going to see an example of how to calculate the put option profit. Let's imagine you are expecting a bad earnings quarterly report for a stock that is currently trading at 50 USD.
You know that the beta of such stock is higher than 1, meaning that the higher volatility could take the current price of the stock to fall below the strike price. Besides, the RSI indicator indicates a loss of price momentum. You decide to buy put options because you expect the price to fall below the strike price.
Target price (TP) = 35 USD
Strike price (SP) = 45 USD
Price of the put option (PPO) = 3 USD
Number of option contracts (n) = 1, remembering that each contract contains 100 options.
Then, the results are as follows:
Total option cost = PPO * n * 100
Total option cost = 3 USD * 1 * 100 = 300 USD
Put potential profit = (SP - TP - PPO) / PPO
Put potential profit = ((45 USD - 35 USD - 3 USD) / 3 USD) * 100% = 233.33%
Put potential return = (SP - TP - PPO) * n * 100
Put potential return = (45 USD - 35 USD - 3 USD) * 100 = 700 USD
The profit of selling that put option would be 700 USD if the stock falls to 35 USD.
In conclusion, calls and puts are another way to make money with stocks together with the dividends and buying cheap and selling high. If you are interested in learning more about investing, like how to find the fair value of a stock, we invite you to check our amazing set of financial calculators.
What is the strike price?
The strike price is the agreed price at which the option owner has the right to buy (in the case of a call option) or sell (in the case of a put option) the shares of the underlying asset. You buy call options expecting that the current stock price goes above the strike price, so then, when you acquire the stock at the strike price, you can sell them for a profit.
How do call options work?
The idea behind call options is that if the current stock price goes over the strike price, the owner of the option will be able to sell the shares for a profit. We can calculate the profit by subtracting the strike price and the cost of the call option from the current underlying asset market price.
How to choose strike price for call options?
Here are three considerations for choosing the strike price:
- Consider time remaining until expiration. The remaining time might affect the options price, but the more time you have, the more likely the stock will hit the strike price.
- The further the strike price is from the current stock price, the lower the option cost because there is less chance for the contract to execute. Remember the option's writer wants to earn your premium. You may have a good bet if you buy the call near the earnings report date.
- Review the stock technically: make sure the relative strength indicator and the moving averages with a clear uptrend.
What happens when a call option hits the strike price?
Option's investors call it "to be at the money". Here, you, as a call owner, have the right to buy the shares at the strike price (named "holding calls"). Remember that even though you are at the money, you are still not profitable because of the options contract price. You can also sell the call option contract. Typically when the stock hits the strike price, the call option cost increases, so you can sell it and earn the difference.
What happens if my call option expires in the money?
If it expires and you did not claim your shares, you end up losing the premium paid and any fees involved. If you had any reason for not buying the stock before expiration and being in the money, you could have sold the option contract as well.
What happens when a call option expires out of the money?
The call option owner loses all the premium and any fees they have paid to obtain the call. Remember that for a call option, you need the underlying asset to go over the strike price to exercise the option and make a profit.
What is a call option in stocks?
A call option is a derivative contract that derives its value from the underlying asset price, for example, a stock. It gives the buyer the right, but not the obligation, to buy shares of a stock at a predetermined price, below the market price. If the owner exercises the call option, he can sell the stock for a higher price and earn money.