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How to Read Option Graphs

Bull Spread Option Graph

Most stock investors are familiar with the typical stock chart, used to show stock prices over time. Price is shown on the vertical axis, and time is shown on the horizontal axis.

Option graphs are different, and may seem a little strange to someone used to stock charts. As shown above, a typical option graph shows the gain or loss of the option position on the vertical axis, and the stock price on the horizontal axis. This is because options are a derivative of an underlying asset, usually a stock. Since they are derived from stock, the most important factor in an option's price is the stock price. So option traders want to see how the option position will gain or lose according to movement in the stock.

Time plays an important part in option trading as well, but instead of using the vertical or horizontal axis to show time, time is represented by different colored lines on the chart. On this site, the blue line represents the value of an option position at different stock prices at the moment you enter the position. The green line represents the value of the same position after half the time to expiration has passed. And the red line represents the intrinsic value of the same position after the options have expired.

On this site we refer to these lines as the "entry line", the "check date line" and the "expiration" line. Taken together, they are the "time lines".

These three graph lines allow you to visualize how any option position will theoretically progress, from the day of entry until expiration.

The blue line crosses the zero gain line, at the stock price at the time you enter the position. This is because the moment you enter a position, there is no gain or loss. However, if the stock moves any amount higher or lower even five minutes later, the blue line will show that a gain or loss would theoretically be made.

The green "check date" line is typically between the blue line and the red line, showing that just the passage of time is having an effect on the option position, no matter what the stock price. Some option positions are helped by the passage of time, and some are hurt.

Any graph that shows the green line above the blue line is showing that at that stock price and IV, the position is helped by the passage of time. Wherever the green line is below the blue line, at that stock price and IV the position is hurt by the passage of time.

The red line shows the intrinsic value of the option position after the options have expired. At expiration, options are either In-the-Money (they have intrinsic value) or they are not (they are worthless).

The reason the blue and green lines are typically curves, while the red line consists of straight line segments, is because up until expiration, all options will have some time value in addition to their intrinsic value. This ever-changing relationship between intrinsic value and time value at different stock prices results in the curved graph lines. After expiration, there is no more time value, so the red expiration line shows just intrinsic value and not the curve caused by changing time value.

Some graphs, such as for the Calendar Call or Double Diagonal strategies, can show curved expiration lines. This is because one or more far expiration "legs" of the option position still has time value at the time the near options have expired.

All option positions are graphed based on the earliest expiration date. The graph for a Calendar Call strategy for example, shows the theoretical progress of the option position up until the first expiration. There is no way to graph a Calendar Call strategy as of the later expiration, since at the time of the later expiration, the first expiration options don't exist anymore. You can certainly graph what is left of the Calendar Call, which may be a long call, but you can't graph it as a Calendar.

On this site, the graphs show the maximum gain with a horizontal blue dotted line and a blue value, on the right side of the graph. It is important to understand that this is the maximum gain AS SHOWN ON THE GRAPH, in other words, covering the range of stock prices on the graph. It is possible for an option position to have a greater maximum gain, or even a theoretically unlimited gain, at stock prices that are not on the graph, but the blue value shows the maximum gain over the range of stock prices on the graph.

The graphs show the maximum loss with a horizontal red dotted line and a red value, on the right side of the graph. It is important to understand that this is the maximum loss AS SHOWN ON THE GRAPH, in other words, covering the range of stock prices on the graph. It is possible for an option position to have a greater maximum loss, or even a theoretically unlimited loss, at stock prices that are not on the graph, but the red value shows the maximum loss over the range of stock prices on the graph.

The graphs show one or two violet-colored vertical lines extending up from the zero gain line, and violet value(s) at the top of the graph. This line or lines represents the breakeven point(s) at expiration for this option position. Some option positions have only one breakeven point, and others have two breakeven points. Depending on the position and whether you are long or short the position, you may want the stock to move beyond a breakeven point, or stay between the breakeven points. Remember that someone who may have taken the other side of your trade wants the exact opposite to happen - for the stock to NOT move, or to move beyond one or the other of the breakeven points.

The graphs show one violet-colored vertical line extending down from the zero gain line to the stock price. This represents the stock price at the time of entry.

Above each strategy graph on this site is a detailed description of the option position. Each leg of the option position that takes money out of your account (a debit) is highlighted in pink. Each leg of the option position that puts money into your account (a credit) is highlighted in green. The total debit or credit for the position is also shown below the leg information. We do NOT include the commission cost of entering or exiting any position, or "slippage" either, and these costs can be substantial. You should always consider those costs, especially for option positions that have four legs. It is easy to find Butterfly or Condor positions that look like a small profit is almost guaranteed. But usually after you factor in commissions and slippage for entering and exiting you find that the only guarantee is a loss.

On the right of the graph we show the Implied Volatility of the options included in the position as of the check date, in a green percentage value. Normally the IV on the check date is kept the same as the IV on the entry date. In some cases, in order to show the effect of volatility on the option position, this value will be different from the entry date values. If this is the case we will make special note of it.

Option graphs do not show option prices! Option graphs show the gain or loss of a position. If you want to know relative option prices from an option graph, you need to do some calculating. In the sample graph at the top of the page, the position cost $165. So anywhere the time lines cross zero, meaning there is no gain, we know that the combined option prices (short and long) must total $1.65: your gain is zero if you bought for $165 and you sell for $165. If the stock is over 55 at expiration, the position gain is $335, so we know the long call must be worth $5.00 more than the short call, because the position cost $1.65 and you made $3.35 (5.00 - 1.65 = 3.35).

 

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