 Hello, and welcome to the session. This is Professor Farhad. In this session, we would look at the values of options at expiration, and by doing so, we're going to look at the profit and loss diagram, which is typically a graph that illustrates this concept. This topic is covered on the CPA, BEC section, as well as the CFA exam, also an Essentials of Investment course. As always, I'm going to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1800 plus accounting, auditing, tax, finance, as well as Excel tutorial. If you like my lectures, please like them, share them, put them in playlists. If they benefit you, it means they might benefit other people. Connect with me on Instagram. On my website, farhadlectures.com, you will find additional resources to complement and supplement this course, as well your other accounting and finance courses. So in this session, we're going to look at the graph, at the profit and loss diagram for stock options. So let's take a look at an example with the call option, the strike price of 80, and the cost of this option is $14. So when does this option pay off for the buyer? Well, obviously it will pay off when you exceed $80. But let's take a look at the graph to see how this exactly worked. So to graph this information, we're going to have a vertical line. And this vertical line, we're going to call it the profit and loss line. And this is 0.0 because we're going to have a profit and a loss. Then we're going to have the strike price, the stock price. This is the stock price, SFT. Okay. And we're going to go ahead and put right here $80. So this is the strike price. This is the strike price. When we have a strike price, it means exactly at this point, the term is we are at the money. Okay, that's the term. There's out of the money in the money and at the money. The strike price is 80. It means that in the strike price, we are at the money. Let me draw this line here. We are at the money. Now here's how it works. If you are the buyer of this, first I'm going to do the buyer. If you are the buyer of this call option, when do you make money? Well, if you're the buyer of this option, you make money when you are in the money, in the money, at 80, at 80, this is at the money. So when you are in the money as a buyer of stock option, as a call option, well, you're in the money when the stock price is 90, 100, 110. Why? Because at this point, you might think about exercising your option because it's above the strike. So here you are in the money. Okay. When are you out of the money? If the stock price at expiration is 70, 60, 50, anything below 80, you are out of the money. Okay. So we already talked about at the money, in the money, out of the money. So let me erase this because we're going to need more space for this graph. Now, remember, as the buyer of this option, as the buyer of this call option, you paid $14 up front to be able to buy the option. Therefore, when you start, when you start, you're going to have, you are at a loss immediately of negative $14 at negative $14. Now, when do you start to make money? Well, you're not going to be making money. Let me use a different color here. Maybe I'll just do dashes. So you're not going to be making money unless the stock price is 80 or above. At 80, you're at the money, but remember, you still have to cover your $14. So when are you going to make money? So as soon as the stock price goes above 80, let's assume the stock price is at 90. If the stock price is at 90, you will start to make a profit. If the stock price is at 90, now you recovered basically $10 from your premium. Now your losses are only $4. Well, if the stock price is 94, at 94, you break even. Why? Because at this point, you paid, you can buy it at 80. So at this point, you can buy it at 80 and you paid $14 at 94 and the stock price is 94. So you break even. Now what happened if the stock price goes from 94, from 94 to 100 and let's make it 94, 104, 104. At this point, you have a profit of $10. You have a profit of $10. If it goes to $114, you have a profit of $20. And notice as you go further, as the stock price goes further and further, your profit goes up. So theoretically, if you are the buyer of the option, your profit is unlimited. Your profit is unlimited because you could always buy it at 80 and sell it for $60 trillion in theory. Now what is your cost? As the buyer, your cost is $14. So for $14, you have a potential of unlimited profit. That's the buyer. Let's look at the seller of the school option. If you are selling, so the buyer, you are bullish. You think the stock goes up. Now as a seller of this stock option, let me change, let me use this color. If you are the seller, the seller, it means you are bearish. What does that mean? It means you don't think the stock price is going to go up. You think the stock price is going to be at 80 or below, and the individual that paid you $14 would never come back and want to exercise. So what happened is this. As the seller of this option, immediately you receive, profit and loss, immediately you would receive, let's assume this is $14. Immediately you received $14. So you immediately have a gain of $14. And you're going to keep this gain as long as the stock price is 80 or below, 80 or below. Now what's going to happen? Once the stock price starts to go above 80, up until 94, you start to lose some of that profit. Up until 94, basically you will have a profit of zero because you have to buy it and deliver it and you no longer have any profit. Your profit is wiped out. If the stock price keeps on rising, then you have to buy it. Let's assume it throws us to 100. If the stock price rises to 100, now you are at a loss of $6. Why? Because you have to buy it and deliver it at 100 and your break even was 94. You have to incur an additional $6 of losses because you have to buy it and deliver it. Actually not at 94, you deliver it at 80 but you broke even at 94. You have 80 plus $14 that cover your expenses. And notice if the stock price keeps on rising, your losses are unlimited. So the seller, the losses unlimited and the profit is only $14. Well, did you notice something? I hope you did that. They're the opposite of each other. They are the mirror image and even the graph itself should be the mirror image. Now, my drawing is not the best but it's the mirror image. Let me show you another drawing of this. So let me delete everything. So what I just talked about, those two images imposed on each other. This is the buyer and this is the seller of the option. They're the mirror image of each other. Now, let's take a look at the put option. Let's assume we're dealing with the put option at $70 and it cost us $10. Now, how does the put option work? Well, when you buy a put option, when you buy a put option, what are you? So if you're a buyer, if you are a buyer, it means you are bearish. What does it mean bearish? It means you fear the price is going to go down because you fear the price is going to go down. You want to protect yourself. So let's go ahead and take a look at the graph for this strike price. So there you go. We have also profit and loss, profit and loss line. We have the stock price, SFT, this is zero and here the strike price is 70. The strike price is 70. Again, at 70, if the stock price is at 70, we call this add the money. Now, as the buyer of the option, if the stock price goes up to 80, 90, 100, that's good. You don't have to do anything, but you are out of the money. So you don't exercise because, you know, why would you sell it at 70 if you can sell it at 80, 90 or 100? What's going to happen is this, when the stock price started to go down to 60, 50, 40, 60, 50, 40, on this end, you become in the money. You become in the money. Why? Because now your option worth something. Okay, your option is worth something. Your stock price is less than the exercise price, which is good. That's what you want. You want to protect yourself. So here you're in the money. Now remember, you paid $10. You paid $10. So here's what's going to happen. You're going to be out of the money, out of the money until you are $70, until you are $70. Then remember, you're basically minus 10. You have minus $10 because you are, you paid $10. You are at a minus 10. You are at a minus 10. And what's going to happen? Once it goes down from 60 to 70, you will start to cut down your profit until it reaches 60. Once it reaches 60, basically now, 60 is your break even. So 70 minus 10, the strike price is 70 minus $10.60. So this is your break even. So this is your break even. Now, here's what's going to happen. As the stock keeps dropping, it goes from 60 to 10 to 50, you will make a profit of $10. If it goes down from 50 to 40, you make a profit of $20. And guess what? If it goes all the way down to zero, your profit is 70 and you paid $10. So your max profit is $60. Your max profit is $60. So your cost is 10. Your cost is 10. You paid $10 in premium. And your max profit is, your max profit is $60. Simply put, if it goes down to zero, they still have it to buy it from you for 70, but you already paid 10. So your max profit is, your max profit is $60. Now, let's take a look. This is the buyer. We said the buyer is bearish. The buyer is bearish. Yes, Dada? I don't know what to do now. Just give me a couple minutes, okay? A few minutes. Okay. Now what's going to happen is we're going to look at the seller of the option, at the seller of the option. The seller of the option is bullish. The seller of the option is bullish. What does that mean? The seller of the option believes what's going to happen is the stock price, it's going to keep on rising. And as a result, if it keeps on rising, you're never going to come back. You're never going to come back to exercise your option. Therefore, in their mind, in their mind, they are going to make a profit of $10 because you're going to pay them $10. Now, how does it work for them? Well, here's what's going to happen. For the seller of the option, as long as the price is above 80, as long as the price is above 80, then use a different color here. I'm sorry, above 70, not above 80. As long as the price is above 80, they will make a profit of $10. This is their profit. And here's what's going to happen. Once it drops below 70, it drops down to 60. Basically, their profit is zero because now they have to make the contract whole and they get $10, but now they basically, they have to buy it at 70 and it's at 60. Therefore, they kind of lost their $10. If the stock price keep on going down from 60 to 50, from 60 to 50, their profit is kind of the scale is not good. The profit will be negative 10 here. And again, as the price of the stock price goes down, they will have more losses. They will have more losses. So what's their max losses? Well, for the seller, what's their max profit? Their max profit is the fee that they get. The fee is $10. What's their max loss? Well, they have to buy it from you for 70, but they already get $10 in fees. So their max loss is $60. That's their max loss. Notice they are the mirror image of each other. The seller will have a max, the seller of a put option will have a max loss of 60. The buyer of the put option will have a max gain of 60. And the cost for the buyer is 10. The profit to the seller is 10. Basically, they're the mirror image of each other. Now, the graph is not the best, but hopefully you guys got the picture. In the next session, we'll look at options versus stock investments, and we'll see how options, how with a little bit of money, you can leverage your position. And it's good to see it, options versus stock investment, to see in numbers how a small amount of money can give you a lot of leverage against an investment. As always, I'm going to ask you to like this recording, share it. And always, I'm going to invite you to visit my website, farhatlectures.com, for additional resources for this course as well as other courses. Study safe, study hard, stay safe, and good luck.