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Option Profit & Loss Diagrams - Options Strategies - Options Trading For Beginners - YouTube
Channel: Option Alpha
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Hey everyone, this is Kirk here again at OptionAlpha.com
and in this video we're going to go through
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options profit and loss diagrams and graphs.
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Profit and loss diagrams help us understand
where and when our option strategy makes money
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or loses money either today or at expiration.
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They're really important to understand and
to master, because it's basically the key
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element to seeing, to visually seeing where
you make money and where you don't based on
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where the stock is.
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Again, it's also important to understand how
they work, because it can help you also build
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complex strategies that profit from the non
directional movement of a stock.
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We're going to look at a live example of a
trade that I have going on right now, at least
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it's on at the time of this video, that shows
you this real life case study and scenario.
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Today we'll go through some graphical representations.
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These ones look really pretty.
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Then we'll look at my trading platform.
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It doesn't look as pretty in most broker platforms,
but again, I think the concept is going to
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be easily transferrable over from one to another.
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Here is your basic P and L diagram or graph
that you might have.
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Again, this is a call option example, and
basically what you're going to have is down
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the left hand side, you're going to have profit
and loss, and that's really easy up and down
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vertically.
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Then what you're going to have, is you're
going to have some sort of zero barrier, or
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stock price barrier that moves laterally left
and right on the chart.
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Basically this is going to be your zero barrier
for profit and loss, or your break even point
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might be something like here.
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Your break even point on this graph, or the
point at which your payoff diagram crosses
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over into a profit potential zone from a loss,
and this line or this representation here
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left and right could be many different stock
prices.
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Basically it means, hey look, if the stock
price is here versus here at expiration, do
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you make money or do you lose money?
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That's basically what we're looking at.
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The line in the middle of the chart or the
red line in our payoff diagram, this is your
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strategy P and L.
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This basically tells you where you make money,
how much money you make, and what stock price
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you need to see to make that amount of money
by expiration.
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Again, everything is in here in this simple
graph.
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Let's go through a couple more different examples.
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Again, this is a call option that we're looking
at first.
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This is a short call option, which is the
complete inverse and opposite here of the
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long call option and in this case you can
see now, and I kind of took away all the wording
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and stuff like that so you can see the representation
of what it's showing, but it's basically showing
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you that you profit anywhere here, and lower.
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Meaning that wherever the stock price is from
here, which is our break even point and lower,
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that is your zone that you potentially make
money on.
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What this P and L diagram shows you is that
with a short call option, your profit is limited
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to the credit that you received.
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We know that from other videos that we've
already gone through here in track one, that
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your short call option profit is limited to
that credit that you received.
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Now you have potentially an unlimited amount
of risk if the stock price continues to move
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higher and higher and higher.
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Again, remember that this black line here
in the middle of the graph, this is the current
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stock price.
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SP to designate that.
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That's the current stock price, either up
or down basically where it moves.
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This is an example of a short put option,
so you can see how the diagram basically shifts
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and changes based on the different strategies
that we're going to choose.
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In this case with the short put option, you
basically want the stock to move higher.
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That basically caps your risk, or our profit
potential to the credit that you received
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in selling that short put option.
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Then basically your risk is limited to just
the value of the stock from your strike price
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down to zero.
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If the stock goes all the way down to zero,
then you'd lose whatever amount of money you
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would lose based on the prices that you choose
and the stock underlying price.
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Those are some basic building blocks.
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Those are your short calls, your short puts.
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We also can use them to now start building
complex strategies.
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In this case, this is a bullish call debit
spread.
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This is a bullshit call debit spread, and
we've got more video tutorials on this so
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you can see, but a bullish call debit spread,
where you would be buying on call option here,
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and then selling another call option at a
different strike price.
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Again, we'll be talking more about complex
option strategies that you can build, but
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now you can visually see how joining two option
strategies together, basically you're joining
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this strategy, buying a call and then selling
a call at a higher price.
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Now you have that combined strategy.
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Now, this is what your payoff diagram looks
like.
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Now you have limited risk to the downside,
and limited risk to the upside.
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This option strategy might be a little bit
different for you.
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It might fit your risk profile and how you
want to trade.
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It might be the type of strategy that profits
from the directional move that you think the
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stock might have.
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Again, we can even get more complex as we
start to build out additional strategies.
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This case is a short iron condor and where
we're only going to profit if the stock stays
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range bound.
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This is a great example of trading non directionally
here, and how this profit and loss diagram
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here can show you that if the stock stays
basically between your two breakeven points,
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which one is here and one is here, that you
end up making money on expiration.
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Okay, so the really, really, good example
of how you can use these P and L diagrams
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to basically see where your potential risk
and reward is.
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Let's look at my thinkorswim platform here.
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We've got a trade up that we currently have
going in our live money real account, all
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of our live money real account stuff is all
stuff that we publicly post and show to our
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pro and elite members.
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This is a P and L diagram for an XOP strangle
that we have.
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Now in this case you can see down here below
that we have the two options that are showing
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and working.
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This is live, real time at the time I'm recording
this, so all of this stuff is going to move
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and shift and adjust, but you can see now
that we are short 2 April 2016 26 puts that
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we sold each for $55 and we also short 2 April
2016 35 calls which we also sold for $27.
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In this case we are net option sellers across
the board.
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We sold a put option contract at the 26 strike.
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You can see that's where the diagram and P
and L diagram pivots.
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Notice how it pivots right there.
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Then we sold a call option at 35.
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Again, you can notice how the call option
diagram pivots and shifts right there.
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Very, very similar to what we did back here
with the iron condor.
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You can see the iron condor has that same
top half shape.
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It pivots and shifts at the same levels.
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We're selling put option and then selling
a call option on the top side.
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Now, in our case with our thinkorswim platform,
the P and L platform is on the left hand side
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here.
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You can see, this is our running P and L.
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We've got our zero barrier which is here,
so this is the zero point.
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Anything basically below that level at expiration,
we lose money.
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Anything above that level, we start to make
money.
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You can see all the different values here
for how much money we can make or lose.
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Now the actual stock that we're looking at
like I said, is XOP.
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As a result, down here on the X axis you have
the different stock prices.
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These are all the different stock prices that
the stock may be trading between now and the
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future.
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Again, it can kind of give you an idea of
where the stock, or if the stock trades at
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X point, how much money you would make or
lose at that point in expiration.
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All you have to do is find the intersection
of the stock price and your P and L graph
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and that shows you how much money you make
or lose.
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Now inside of thinkorswim, most of the time,
and most broker platforms have this.
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It's not just thinkorswim, but that's the
one that we use.
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A lot of the other ones like Dough and TradeStation
and all the other ones, Trade King, they all
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have very much the same thing, but mostly
what they'll have is they'll have some sort
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of dotted line or line representing the current
stock price somewhere right in the middle
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of your payoff diagram.
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In this case, the current stock price is $30.75.
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It might be hard to see unless you've maximized
this video, but it's all record in HD so you
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should be able to see this.
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Currently XOP is trading for $30.77 now, because
it's actually trading live time.
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If we actually just visually go up this P
and L graph here at $30.77, you can see that
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it now intersects with this green line, which
is our payoff line for our strategy.
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Now this green line is the expiration line
for us, or is the payoff at expiration, meaning
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the end of the April cycle, whenever the April
cycle fully goes through.
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Right now, as long as the stock stays basically
between 26 on the put side, and 35 on the
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call side as far as a price, so the underlying
security, we can make at expiration, about
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$164.
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That's our max potential profit, is $164 on
this particular trade.
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Now right now the trade is working out in
our favor and we're already making some money
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on this trade, but you can see that basically
all we need this stock to do is stay between
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26, which is here, and 35 on the top side
and we make money, $164 at expiration.
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If we go over to the chart here of XOP, you
can see that 26 is basically here, and 35
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is basically here.
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This is that type of strategy that I've talked
about earlier in these videos, that we don't
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care where the stock goes.
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It could trade to 32, down to 27.
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It could trade all over and all over this
place and in this zone.
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As long as it stays between those two strike
prices, then we have an opportunity to make
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a maximum amount of money on this particular
trade.
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Now let's say for example that the stock actually
closed up around $37.
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This is where you can kind of see where your
risk is.
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Let's assume that the stock actually closes
at expiration up around $37.
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In that case, we would just take our 37 strike,
go up to wherever it intersects with our P
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and L chart, which you can see is right here,
and then go left from there, and you can see
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that ad expiration.
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If the stock was at $37, we would lose a little
over $200 on this trade.
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If the stock actually moved all the way up
to $37 at expiration, then we would lose about
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$200 on this trade.
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If it moved up to 38 at expiration, then we
would lose about $450.
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You can see how hopefully I'm just visually
going left and right, up and down, based on
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stock price and my P and L diagram here.
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Hopefully that makes sense.
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If you have questions ask them in the comment
box right below.
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The last thing that you'll see on these P
and L charts, at least on the thinkorswim
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chart, is you'll see this purple line here.
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Now this purple line gets people a little
bit confused, and the way that I traded is
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I'm always concerned about more so my P and
L graph at expiration, which is this green
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line.
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That's the money maker, because that's the
one that I'm concerned about if the trade
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has to go all the way through the expiration
month.
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What this purple line shows, is this purple
line shows your P and L today, so how much
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money you're making today based on the current
stock price, implied volatility, and the market
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move that's happening.
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What the difference is between basically the
purple line and the green line, is the difference
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in time value or volatility value.
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Here's a good representation of how this works.
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Let's say for example, that the stock is,
or let's just use the current stock price
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right now of $30.83.
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You can see it's trading as we're doing this
video.
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Currently, at $30.83 today, we have made $93.97
on this trade.
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That is the current profit that we are holding
right now.
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If we wait and hold this thing between now
and expiration, which is another 25 days away,
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then we can make another, basically $64 on
this trade.
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Remember our max return is about $64.
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We've already made about 100 bucks.
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That difference in this line shows you how
much money you make or lose now versus at
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expiration.
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Where it's really helpful is in a situation
like this where if the stock, let's say for
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example, today XOP was trading at 26 versus
30.81.
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Let's say the new price suddenly was $26.
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Instantly you'd actually be losing on this
trade about $100 today.
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Your loss today would be $100.
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Now, if you were smart and you start looking
at these option P and L charts and these diagrams,
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you'd realize that if the stock actually stayed
there for the rest of the expiration cycle,
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you'd actually make your full profit if they
stock stayed there.
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It might either help you stay in or stay out
of the trade obviously, but just knowing that
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your loss today at $100 is just today's loss.
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It's not how much you would lose at expiration
trading this strategy.
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That might help you be more confident in how
you trade that particular security.
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Let's look at another example here.
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I want to look at DIA, and we're going to
build a strategy here in DIA real quick.
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Just do a long call option in DIA.
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Again, you can see this P and L chart start
to evolve and move.
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Now this is a long call option.
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Again, let's go back to our slides here.
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This is what this payoff diagram looks like
for a long call option.
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Probably should have started with this one,
but it's okay.
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I want to challenge you guys a little bit
and hopefully get you a little bit faster
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into the options trading space.
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In this case, again, our strike price for
doing this long call option is the 176 strike.
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That's exactly where the P and L diagram pivots.
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Again, what we're concerned about is this
green line here.
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That's our profit and loss at expiration right
now.
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The purple line is our P and L today.
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Now obviously if we enter the trade today,
and the stock is trading right here, we can't
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really make or lose money based on where the
stock is trading now because we paid a premium
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to get into this trade.
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That's the premium that we paid here of $2.10.
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Now you can see on the P and L chart on the
left hand side, our maximum maximum maximum
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risk is $210 on this trade.
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Even if the stock closed down to not 169,
and it's currently trading at 175.93, even
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if the stock moved all the way down to 169,
we'd still only lose $200.
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If it moved down to 173, we'd lose $200.
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If it moved down to 175, we'd lose $200.
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You can see how this payoff diagram shows
you where your risk is and not.
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Now, in this case, we also have to add the
strike price, plus our debit that we paid
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to get into this contract.
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We add these two things together, so the 176
plus the 208, and that gives us our new break
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even point here, basically at about 178 and
change.
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Now we realize that the stock is trading here
at 176, but we really need the stock to trade
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above 178 for us to make money at expiration.
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Again, if we were choosing to do the call
options, then we are basically forcing the
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market to make a move at least up to 178 for
us to make money at expiration.
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Again, this is our zero barrier here, this
line right in the middle.
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This tells us how much money we make or lose
at expiration.
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Hopefully that was a really good example,
again going through all of these P and L charts.
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Take your time and play around with some of
these, whatever broker platform you use.
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Go back through this video, head into the
different video training modules that we have
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here at OptionAlpha and learn how these different
P and L charts can effect different strategies,
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because this is really critical to your understanding
of how we can build strategies that generate
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consistent monthly income.
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Thank you so much for watching.
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If you have any comments or feedback let me
know.
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If you love it, please share it online.
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Help spread the word about what we're trying
to do here at OptionAlpha.
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