Using options for tax management

Investors sometimes use options to change portfolio allocations without actually buying or selling the underlying security. For example, an investor may own 100 shares of Reliance and be liable for a large unrealized capital gain. Since they do not wish to trigger a chargeable event, Shareholders can use options to de-risk the underlying security without actually selling it.12 In the above case, the only cost to the Shareholder of using this strategy is the cost of the options contract itself .

Using options for speculation

Options contracts offer buyers a chance to gain significant exposure to a stock at a relatively low price. Used in isolation, they can generate significant gains when a stock goes up. But they can also result in a 100 percent loss of premium if the call option expires worthless because the underlying stock price does not exceed the strike price. The advantage of buying call options is that the risk is always limited to the premium paid for the option. Investors can also buy and sell different call options at the same time, creating a call spread. These limit both the potential gain and loss from the strategy, but in some cases are less expensive than a single call option because the premium from writing one option offsets the premium paid for the other.

Using options for income

 Some investors use call options to generate income through a covered call strategy. This strategy consists of owning an underlying stock and at the same time writing a call option or giving someone else the right to buy your stock. The investor collects the option premium and hopes that the option expires worthless (below the exercise price). This strategy generates additional income for the investor, but it can also limit the potential for profit if the underlying stock price rises sharply. Covered calls work because if the stock rises above the strike price, the option buyer will exercise their right to buy the stock at the lower strike price. This means that the option writer does not benefit from the stock movement above the strike price. The option writer's maximum gain from the option is the premium received.

How to Calculate Call Option Payoffs In Option CallPut

How to Calculate Call Option Payoffs

Call option payoffs refers to the profit or loss that an option buyer or seller makes on a trade. Remember that there are three key variables to consider when pricing call options: strike price, expiry date, and premium. These variables calculate payouts generated from call options. There are two cases of call option payoffs.

Payoffs for call option buyers

Suppose you buy an option to buy company ABC for a premium of RS2. The exercise price of the options is RS50 and has an expiration date of November 30th. You will break even on your investment when the ABCs share price reaches RS52, which is the sum of the premium paid plus the share purchase price. Any increase above this amount is considered a win. Therefore, if the ABCs stock price increases in value, the payoffs is unlimited. What happens if ABCs share price falls below RS50 by 30th November? Because your option contract is a right, not an obligation, to purchase ABC stock, you may choose not to exercise it, which means you are not buying ABCs stock. In this case, your losses are limited to the premium you paid for the option.

Payoff = spot price - strike price

Profit = payoff - premium paid

Using the formula above, your profit is RS3 if ABC's spot price is RS55 on Nov. 30.

Payoff for call option sellers

The payoffs calculations for the seller of a call option are not very different. If you sell an ABC options contract with the same strike price and expiration date, you only gain if the price falls. Depending on whether your call is covered or uncovered, your losses may be limited or unlimited. The latter case occurs when you are forced to buy the underlying stock at spot prices (or perhaps even more) if the option buyer exercises the contract. Your only source of income (and profit) in this case is limited to the premium you receive when the options contract expires.

The formulas for calculating payoffs and profits are as follows:

Payoff = spot price - strike price

Profit = payoff + premium

Using the formula above, your income is RS1 if ABC's spot price is RS47 on Nov. 30.