Call Options and Put Options: Understanding Payoffs in Options Trading
What are the payoffs per barrel for a financial manager who buys call options and sells put options on oil with different oil prices?
Oil prices: $57, $63, $66, $69, $75
The financial manager's payoffs per barrel are as follows: -$9, $0, $0, $3, and $9.
Options trading involves buying call options and selling put options on underlying assets such as oil. In this scenario, the financial manager purchased call options on 12,000 barrels of oil with an exercise price of $66 per barrel and simultaneously sold a put option on the same quantity of barrels with the same exercise price.
Call Options:
A call option gives the buyer the right, but not the obligation, to buy the underlying asset at the exercise price within a specified period. If the oil price is below the exercise price, the call options are not profitable for the financial manager. In this case, the payoff per barrel is the difference between the exercise price and the actual oil price. For example, if the oil price is $57, the payoff per barrel is -$9.
If the oil price is equal to or higher than the exercise price, the call options are profitable, and the payoff per barrel is zero as the options will not be exercised.
Put Option:
By selling a put option on the same exercise price and quantity of barrels, the financial manager is obligated to buy the oil at the exercise price if the put option is exercised. If the oil price is below the exercise price, the financial manager will incur a loss equal to the difference between the exercise price and the actual oil price. For instance, if the oil price is $57, the loss per barrel is -$9.
However, if the oil price is equal to or higher than the exercise price, the put option will not be exercised, resulting in zero loss per barrel for the financial manager.
Overall Payoffs:
Considering both the call options and the put option, the financial manager's payoffs per barrel for different oil prices are as follows: -$9 ($57 oil price), $0 ($63 and $66 oil prices), $3 ($69 oil price), and $9 ($75 oil price).