The general idea with an option is that you want to make a profit on speculation on the movement of the price of a security in the market, over a predetermined time frame.
The amount of profit or loss from the option can be calculated using a combination of the upfront premium and the payoff value of the option upon expiration. It is a zero-sum game as when a buyer profits by a certain amount, the seller loses the same amount, and vice versa.
The following table summarizes all of the profit and loss situations for both the buyer and seller when entering into options contracts:
|
Type |
Scenario |
Buyer or seller |
Net profit or loss |
Cash flow |
At the end of the window period |
Net amount |
|---|---|---|---|---|---|---|
|
Call |
The maturity price is above the strike price and the premium is less than the payoff |
Buyer |
Profit |
-Premium |
The buyer buys the underlying instrument at a discounted price from the seller |
-Premium + payoff |
|
Seller |
Loss |
+Premium |
The seller sells the underlying instrument... |