Options profit calculators help determine the maximum gain and loss potentials of options trades. The tool also provides users with some insights into market dynamics. With this information, traders will be able to make more educated decisions.
Here are the steps to use these calculators to make the most of your basic trading strategies.
Set up the Trade Parameters
Understanding and setting up the trade parameters for any options strategy is the first step to using an option price calculator.
Different options strategies call for different numbers of specific calls or put to be traded. For example, a vertical spread will require two calls or puts that are bought and sold simultaneously. The time factor of the trade will determine whether these are put or call options.
For simplicity, this calculator will assume that the trade takes place at the end of its period (and not when executed). Also, note that long and short trades can be simulated in an options profit calculator to determine their potential gains and losses.
The Purchase Price of the Option
The option's purchase price consideration is the next stage, usually representing the bid price of an option contract. This calculator assumes that only one option contract is purchased at a time, so no additional purchase prices for spreads or combinations are necessary.
The potential gains and losses from opening a position can be determined by simply entering these values into the options profit calculator in addition to the purchase price.
Note that maximum losses will be easy to determine and usually represent 100% of the capital at risk (if buying a put or call). However, calculating potential gains can get tricky and require some calculations outside the options profit calculator.
The potential gain for a long position is calculated by:
Maximum Profit = Unlimited - Purchase Price
The potential loss for a long position is calculated by:
Maximum loss = Purchase Price - Unlimited
Finally, note that the 'Unlimited' value is the strike price plus the premium paid minus any interest costs. For example, if an option has a strike price of $50 and costs $5 to buy with no interest cost, then the 'Unlimited' price would be $55. This is because there are no additional interest costs since the option was purchased at the same time when the stock itself was purchased.
The potential gain for a short position is calculated by:
Maximum Profit = Unlimited + Purchase Price - Premium Received
The first step is determining which price movement you think is likely to happen after an options contract is purchased. Investors have a broad range of options in this regard, including directional price movements and volatility.
Directional price movement refers to the general direction of a stock's price over a given time. This could be upwards or downwards. If investors think that Apple Inc. will rise in value over the next two months, they will take a bullish position.
Volatility refers to how volatile an options contract is likely to be. Stocks known to fluctuate dramatically in price over short periods are said to have high volatility. Options contracts for stocks with higher volatility tend to pay out much more than those with low volatility.
After making this determination, investors can choose the expiration date and strike price they want to use. These contracts often expire monthly or quarterly, with most investors choosing to follow the shorter-term performance. The strike price is where the options contract begins to gain value.
For example, if you look at Apple Inc.'s stock throughout 2017, you'll see that it has had unusually large movements in both directions. On the other hand, the benchmark SPY index has moved only slightly in either direction for this time frame.
Remember that options trading may carry a significant risk of loss beyond what is covered by the margin. Additionally, there are costs involved in investing in securities, such as commissions and spreads.
Reading the Trade Statistics
The options-trading industry seems to be booming. If you walk into your local brokerage or even peruse the internet, it is easy to see that most people involved in this trade are looking for ways to optimize their investment strategies.
Using an options profit calculator allows investors to input different variables in an automated fashion to give them a clear idea of how the investment will work in theory.
If you decide to invest in options, always do your research and understand the risks involved. A calculator can be a useful tool for obtaining an overall understanding of how options work.