Definition: An options profit is the sum that an investor earns by buying a call option or selling a put option at maturity.
What Does Options Profit Mean?
What is the definition of options profit? If an investor has entered a call option agreement, he expects the market price of the underlying asset to be higher than the strike price at maturity. The investor will receive an income by having the right to buy the underlying asset at the strike price and sell it in the open market at the market price.
If an investor has entered a put option agreement, he expects the market price of the underlying asset to be lower than the strike price at maturity. The investor will receive an income by having the right to buy the underlying asset at the market price and sell it in the open market at the strike price. In both cases, the net profit for the investor is the difference between the strike price and the market price, minus the premium paid for the call option or the put option.
Let’s look at an example.
Example
Martin owns 100 shares of an auto manufacturing company, which currently trade at $55. Martin believes that the price of the stock will go up as the company has released remarkable financial results in the recent quarter. Therefore, Martin buys a call option on the stock at a strike of $50, speculating that the stock price will go up considerably before maturity, and he pays $200 ($2 is the price of the option to acquire 100 shares).
If the stock price rises to $65, Martin has the right to exercise his call option by buying 100 shares of the auto manufacturing company for $50 and selling them in the open market for $65, thus realizing a profit of ($65 x 100) – ($50 x 100) = $1,500. His net profit is $1,500 – $200 = $1,300.
Alternatively, Martin believes that the price of the stock will go down because the results of the recent quarter could be even better. Martin buys a put option at a strike price of $50, for $2 per share, and he pays $200, speculating that the stock price will decline significantly below the strike price of $50 before maturity. If the market price drops to $38, Martin has the right to exercise his put option by buying 100 shares for $38 and selling them in the open market for $50, thus realizing a profit of ($50 x 100) – ($38 x 100) = $1,200. His net profit is $1,200 – $200 = $1,000.
Summary Definition
Define Option Profit: An option profit is the amount of net income an investor earns from buying and selling call and put options.
