Options risk graph – part 1
What is Options Risk Graph ?
Risk graph is pictorial representation of profit or loss from an option position /strategy for various price levels of underlying security.
They are fundamental tool for analysing options positions, breakeven points etc. They are also known by alternative names of Reward Risk Graph, P&L graph etc.
Main components of Risk graph are -
X-Axis = It carries different price levels of underlying. As underlying can’t fall below ZERO price, we will have only +ive values for X-Axis
Y-Axis = It shows the net profit or loss of the position. As position can get into losses, hence Y-Axis will have the -ive values too.
Profit zone = Zone above the X-axis
Loss zone = Zone below the X-axis
Break-even point= The point at which the risk graph crosses the X axis.
Risk Graph – The line that connects net P&L for each price level of underlying security at expiry. It will also show the max profit, max loss and breakeven points.
How many types of Risk Graphs are there ?
There are 6 basic risk graph format. Risk graph for various options strategies can be drawn by combining theese 6 graphs.
- Long Stock
- Short Stock
- Long Call
- Short Call
- Long Put
- Short Put
In future posts, I will explain each of them with example.
Feel free to leave the comment below if you want any clarification.