How to Calculate Put Option Profit and Loss

This article provides a clear, step-by-step guide to calculating profit and loss from buying a put option. It focuses on the mechanics of this calculation, helping readers understand how potential outcomes are determined for put option investments.

Understanding Put Options and Terminology

A put option grants its holder the right, but not the obligation, to sell an underlying asset at a specified price on or before a particular date. Investors typically purchase put options when they anticipate a decline in the underlying asset’s price or to protect against potential losses in an existing portfolio holding.

The “underlying asset” refers to the security, such as a stock or index, on which the option contract is based. The “strike price” is the predetermined price at which the underlying asset can be sold if the option is exercised. The “premium” is the price the buyer pays for the option contract, typically quoted per share but representing a total cost for a standard 100-share contract.

The “expiration date” marks the final day the option can be exercised. An option is “in-the-money” (ITM) when the underlying asset’s price is below the strike price, making it profitable to exercise. Conversely, it is “out-of-the-money” (OTM) if the underlying asset’s price is above the strike price. An option is “at-the-money” (ATM) when the underlying asset’s price is equal or very close to the strike price.

Inputs for Put Option Profit Calculation

Calculating profit or loss from a put option requires specific numerical inputs.

The “strike price” is a fixed component of the option contract, representing the agreed-upon selling price of the underlying asset. This value is clearly stated when the option is purchased. The “premium paid” is the upfront cost incurred to acquire the option contract. Remember that option premiums are usually quoted on a per-share basis, so a premium of $2.00 actually translates to $200 for a single contract, which typically covers 100 shares of the underlying asset.

Finally, the “underlying asset price” at the time the option is either sold or exercised is a variable input. Transaction costs, such as brokerage commissions, should also be considered as they reduce net profit or increase net loss.

Calculating Put Option Profit

The fundamental formula for calculating profit or loss from a long put option is: Profit/Loss = (Strike Price – Underlying Asset Price) – Premium Paid.

To apply this formula, first determine the intrinsic value of the option by subtracting the underlying asset’s current market price from the strike price. Next, subtract the total premium initially paid for the option contract from this intrinsic value. A positive result indicates a profit.

A negative result signifies a loss, which is limited to the premium paid if the option expires out-of-the-money or is sold for less than the premium. The “break-even point” for a put option is reached when the underlying asset’s price equals the strike price minus the premium paid. At this specific price, the trade results in neither profit nor loss.

Illustrative Examples

These examples demonstrate how different market movements affect the outcome of a purchased put option.

Profitable Scenario

An investor buys a put option with a strike price of $50 for a premium of $3.00 per share. This means the total cost for one contract (100 shares) is $300. If the underlying asset’s price falls to $40 by expiration, the intrinsic value is $50 (strike) – $40 (underlying) = $10 per share. The profit is then calculated as $10 (intrinsic value) – $3 (premium) = $7 per share, or $700 per contract.

Loss Scenario

Using the same $50 strike price and $3.00 premium, imagine the underlying asset’s price only falls to $48, or even rises to $55. If the price is $48, the intrinsic value is $50 – $48 = $2 per share. The loss would be $2 (intrinsic value) – $3 (premium) = -$1 per share, or a $100 loss per contract. If the price rises to $55, the option expires out-of-the-money with zero intrinsic value, and the full premium of $300 is lost.

Break-Even Scenario

With the $50 strike price and $3.00 premium, the break-even point is $50 (strike) – $3 (premium) = $47. If the underlying asset’s price lands exactly at $47 at expiration, the intrinsic value is $50 – $47 = $3 per share. After subtracting the $3 premium, the profit is $0, resulting in neither a gain nor a loss on the trade.