By keeping in mind, the intrinsic value of a put option, let’s create a table that helps us determine the potential profit or loss for the buyer of Bank Nifty’s 18400 put option upon expiry, considering different changes in the spot market. It’s crucial to remember that the premium paid for this option was Rs 315, which remains constant regardless of the spot value. To have a clear understanding of the profit and loss, we should consider this expense while constructing our profit and loss table.
Please note that the negative sign preceding the premium paid indicates a cash outflow from the trading account.
Let us take note of the P&L’s behaviour and make some generalizations about it. Let row 8 be our point of reference for the conversation.
This general formula can be utilized to calculate the profit and loss (P&L) from a put option position when held until expiration. Remember:
P&L = [Max (0, Strike Price – Spot Price)] – Premium Paid
Let’s take two random values and evaluate if the formula holds true:
Value 1: 16510
Value 2: 19660
For Value 1 (spot below strike, position expected to be profitable):
P&L = [Max (0, 18400 – 16510)] – 315
= 1890 – 315
For Value 2 (spot above strike, position expected to incur a loss, limited to the premium paid):
P&L = [Max (0, 18400 – 19660)] – 315
= [Max (0, -1260)] – 315
Both results align with the expected outcomes.
Now, let’s understand how to calculate the breakeven point for a put option buyer. As we discussed this in a previous chapter, I will provide you with the formula:
Breakeven Point = Strike Price – Premium Paid
For the Bank Nifty, the breakeven point would be:
Breakeven Point = 18400 – 315
According to this breakeven point definition, at 18085, the put option should neither gain nor lose any money. To validate this, let’s apply the P&L formula:
P&L = [Max (0, 18400 – 18085)] – 315
= [Max (0, 315)] – 315
= 315 – 315
The outcome confirms the expectation of the breakeven point.
It is essential to note that all calculations of intrinsic value, profit and loss, and breakeven point are with regard to the expiry date. We have presumed that you, as an option buyer/seller, plan to keep the trade until its expiration.
Soon, you’ll discover that more often than not, you will open an options trade, but close it much earlier than expiration. Calculating the break-even point in such a scenario may not be important; however, working out the P&L and intrinsic value is significant and requires a different formula.
Let us look at two scenarios on the Bank Nifty Trade with its start date of 7 April 2015 and expiry of 30 April 2015.
The first question’s answer is quite easy. We can directly apply the profit and loss (P&L) formula:
= Max (0, 18400 – 17000) – 315
= Max (0, 1400) – 315
= 1400 – 315
Moving on to the second question, if the spot rate is other than 17000 at any point other than expiration, the P&L won’t be 1085; it will actually be greater. We’ll explore why at a later stage, but just keep that in mind for now.
– Put option buyer’s P&L payoff
By connecting the P&L points of the Put Option and plotting it on a line graph, we should be able to confirm our generalizations about the profit/loss for buyers of this security.
The chart presents several elements worth noting. Of particular interest is the 18400-strike price, but there are other details to keep in mind as well.