The best way to calculate the profit from Options is to use the services of an Options Calculator. Usually, these tools will provide information about the possible profit or loss on contracts for the purchase or sale of this type of investment.
Let’s learn more about this type of operation, from contracts to methods of calculating profits on these contracts.
What are options contracts?
These are derivative financial products. A derivative financial product derives its value from the evolution of another asset.
There can be derivatives on shares, commodities, market indexes, etc.
Therefore, the value of an option will be measured by the evolution of the asset to which it is derived: also known as the underlying asset.
In general, options contracts are derivatives used to speculate on how a particular asset will evolve in the market in the future.
Options are divided into two types of contract:
Call options give you the right to buy an asset at a certain price within a certain period.
The right does not mean the obligation of the purchase, and it is possible not to execute it. The investment is made at a price agreed in advance regardless of the market price at the execution time.
The use of a call Option allows the possibility to buy shares (or other assets) at a lower price and then make a profit if those shares rise in value. However, the opposite can also occur since it is possible to buy shares at a price expecting them to go up, then their price goes down. In the latter case would generate losses.
Put Options allow an acquired asset to be sold at a specific price within a period determined in the contract. This sale will be made at the agreed price regardless of the asset’s market price when the option is exercised.
As with the call option, this is a right, not an obligation.
In the put option, the expectation is that the price will fall below the pre-set price. When the price drops, the gain is obtained. If the price rises, a loss is generated.
When to choose call options when to choose put options?
As we have seen, call and put options are different. The strategies to be applied in both cases are also different.
When a call option is exercised, it will make a profit if the underlying asset price is higher than the initial purchase price. Usually, these options are exercised for companies or assets with a strong appreciation potential or that have a justifiable projection of an increase in value.
In the case of the put option, gains are obtained when the price of the asset falls below the purchase price. In this case, the strategy advises betting on companies with high equity debt, assets in a complex situation in terms of declining interest coverage rate, etc.
On the other hand, interest rates and the collapse of highly leveraged environments can also favor this type of position when contracting options.
How do the profit calculators work on an Option?
These are simulation tools. They take into account aspects such as:
- Purchase price and target price: these would be the prices of the assets on which the options are to be applied. Therefore, the prices from which the value of the operation is derived.
- Exercise prices: these are the predetermined prices of the asset on which, if the stock rises, can exercise the call option.
- Option prices: valuing contract prices in terms of the gain/loss dynamics they may represent.
Other aspects that can be considered are the cost of purchases when dealing with commodities, the number of contracts to be purchased, etc.
The potential profitability of the operation provides an estimate of whether it can be a positive or negative move for the investor. The calculators are not infallible elements and do not have an exact result. However, they make it possible to consult possible trends, directions, or projections of a call or put option.
They are, therefore, a complementary tool to other types of investment signal systems. They can be useful, and in the market, you will find a good number of calculators that allow you to obtain this information.
The simpler ones will give less reliable results but are easier to handle. The more complex ones require a high volume of data and added information: they are more reliable but unsuitable for novice investors.
For years I have studied American finance regulations. All the information in this blog is sourced from official or contrasted sources from reliable sites.
Salesforce Certified SALES & SERVICE Cloud Consultant in February 2020, Salesforce Certified Administrator (ADM-201), and Master degree in “Business Analytics & Big Data Strategy” with more than 13 years of experience in IT consulting.