Risk Graphs
Risk graphs are the graphical representation of the underlying risk of a stock and/or option position. In this article, we’re discussing an option risk graph.
In order to understand the inherent risks of an option position, traders can use a risk graph to see the profit/loss possibilities of certain outcomes.
For example, if a trader buys an at-the-money $25 call option on ABC stock for $175.00 (100 x $1.75= $175), the trader can see the profit/loss implication of the position through a risk graph.
Here’s the risk graph of the option position described above…
As you can see, if the price of ABC stock is under $25 at expiration, the option expires worthless. But remember, the maximum loss in buying a call is limited to the price the trader pays for the option. In this case, it’s $175. That’s why the blue line is flat to the left of the $25 mark.
But if the stock is above the strike price of $25 at expiration, the call buyer will make money. That’s why the blue line starts rising once the $25 area is breached.
Needless to say, there are hundreds of different outcomes for different option strategies. Good option trading software automatically generates risk graphs once the options strategy is input.
Category: Options Trading Basics
