Options trading, although complex but is the most exciting component of investment. It offers high leverage and at the same time gives investors a chance to earn a good yield. If you are thinking of investing in options contract then learn how to calculate profit on the call option.
Before digging deep, let’s first learn about what the call option is?
A call option is a type that gives an investor a right but not an obligation to buy a particular asset at a fixed price at a predetermined date in the future.
So, if you are bullish on a particular stock but at the same time want to minimize losses you might suffer due to high volatility and fluctuation in stock price.
Although stock analysis is important and can prevent you from facing loss but picking the right strike price and gaining a proper understanding can help you in calculating call option profit.
Let’s dive in to learn the proper method to determine call option profit.
Call option Profit Explained
When a trader buys a call option, he has an idea of the loss he can suffer from the trade. Since here the trader has an option, so he exercises the trade only when the value of the asset reaches the strike price or at the value where he can earn a good profit.
The amount of premium usually fluctuates based on the amount of the risk and time left for option expiry.
In general, a call option buyer can earn profit only if the stock price rises above the strike price before expiry. Although here the exact profit depends on the difference in the stock price and the strike price on the date the option expires.
On the other hand, the call option writer is the one who makes a profit if the underlying asset price is less than the strike price. Thus, the call option writer profit is the premium he or she received while writing a call opt1ion.
How to Calculate Long Call Option Profit?
A long call option is bought with the objective that the price of the underlying asset will rise beyond the strike price before expiry. If you are thinking that you can sell the call option without strike price, then that is not possible in real life.
Now understanding profit percentage, it is a little challenging to predict, because of no limit of how much the stock price can rise at expiration.
But on the basis of analysis and other parameters, you can actually get an idea of how much you can earn in call option trade.
Other than this there is a Call Option profit calculator that further helps you in gaining the right knowledge and understanding call option profit.
Call Options Profit Formula
To get the exact idea of the call option profit calculation, you have to consider various parameters like the risk appetite i.e. how much risk you can take to trade in a particular call option trade.
Other than this the value of strike price and premium defines the breakeven point that eventually helps you to calculate the exact profit you can make with the trade.
Here the breakeven point is the sum of strike price and premium paid.
Breakeven Point= Strike Price+Premium Paid
Now to calculate the profit you can use the formula below:
When the price of the underlying stock is more or equal to the strike price, then profit is calculated by adding long call and premium paid.
Price of Underlying Asset >= Strike Price of Call + Premium Amount
Profit= Price of underlying asset-Strike Price-Premium Amount
Call Options Profit Example
To get a clear view of the profit one can earn with call option trade, let’s take an example.
Suppose the stock of Reliance company is trading at ₹2000. A call option strike price of ₹2040 expiring in the month is available at ₹200.
Now since you are bullish on the particular stock, you paid the premium of ₹20,000 (₹200*100 shares per lot) to buy one lot of Reliance shares.
Now here let’s assume that your share market prediction goes in your favor and the stock price reaches ₹2900, thus you now have the right to buy 100 shares of Reliance at ₹2040 and selling those shares in the open market at ₹2900 per share thus making a profit of ₹860 per share.
Putting the value in the formula above let’s calculate the profit per share:
But here since you paid a premium of ₹200 per share, the total profit will be ₹660 per share thus making a net profit of ₹66,000.
On the other side, if your prediction goes wrong, and the stock price drops to ₹1900, then your call option will expire worthlessly and you will suffer a loss of ₹20,000 i.e. premium paid at the beginning of the trade.
Other than this you have to pay brokerage against the trade to your broker that varies from broker to broker.
However there is the chance to earn unlimited profit in a call option trade, but it is good to little cautious while picking the strike price.
For this, you have to analyze the risk factor to make a decision of going to a strike price in-the-money, out of the money, and at the money.
This will define the initial investment you have to do to buy a call option and further in calculating the break-even point that helps you in calculating the overall profit you can make with the call option trade.
So, trade smartly and do proper analysis especially if you are trading by leveraging margin facility from the broker.
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