Risk Graphs

| April 13, 2012 | 0 Comments

Risk GraphsRisk 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…

risk graph

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.

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Category: Options Trading Basics

About the Author ()

Marcus Haber is the co-editor of Options Trading Research and boasts well over a decade of real-life options experience. Learning from some of the biggest names in the business, Marcus has served as an Options Strategist for a number of firms and was also appointed to the Options Advsiory Board with Pershing, a branch of the Bank of New York.

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