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 potential profit or loss on options contracts.
Let’s learn more about how this works, from options 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 performance of another asset.
There can be derivatives on equities, commodities, market indexes, etc.
Therefore, the value of an option will be measured by the performance of the asset to which it is derived: also known as the underlying asset.
In general, options contracts are derivatives used to try to speculate on how a particular asset will evolve in the market in the future.
Options are divided into two types of contract:
Purchase options
Call options give you the right to buy an asset at a certain price within a certain period.
The right does not mean an obligation to buy, but it is possible not to exercise it. The purchase is made at a price agreed in advance regardless of the market price at execution.
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, whereby shares can be bought at a price expecting them to grow, and then their price falls. In the latter case, it would generate a loss.
Sale options
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 and not an obligation.
In the put option, the expectation is that the price will fall below the pre-set price. When the price drops, a profit is made. If the price rises, a loss is generated.
When do you choose call options or 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 price of the underlying asset is higher than the initial purchase price. Typically, these options are exercised for companies or stocks with a heightened appreciation potential or justifiable projection of an increase in value.
In the case of the put option, gains are realized when the asset price falls below the purchase price. The strategy advises betting on companies with high debt capital, assets in a complex situation regarding declining interest coverage rates, etc.
On the other hand, interest rates and the collapse of highly leveraged environments can also favor this position when contracting options.
How do benefit 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 will apply. Therefore, the costs from which the value of the transaction is derived.
- Strike prices: these are the predetermined prices of the asset above which, if the stock rises, can exercise the call option.
- Option prices: valuing the costs of the contracts in terms of the profit/loss dynamics they may represent.
Other aspects that can be considered are the purchase cost, in the case of commodities, the number of contracts to be purchased, etc.
The potential profitability of the transaction gives an estimate of whether it can be a positive or negative move for the investor. Calculators are not infallible, and they do not have an exact result. However, they allow you 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 some calculators on the market allow you to obtain this information.
The simpler ones will give less reliable results, but they are easier to use. The more complex ones require a high volume of data and added information: they are more reliable but are not suitable for novice investors.