Options Calculate Break Even Price
For a business owner, knowing their breakeven is a really important deal.
In basic terms, the breakeven is the point at which the revenue coming in matches the total of all costs going out. Any money received on top of these costs becomes the company’s profit.
To illustrate the breakeven, we’ll use a call option. As the definition goes, a call option gives the buyer the right to buy the underlying shares, at the strike price, up until the option expires. For taking on this obligation, the option seller receives a fee, called the premium, from the option buyer.
The strike price represents the agreed price at which the call option seller must hand over the underlying shares to the option buyer, if the buyer exercises the option.
This strike price becomes the basis from which to work out the breakeven, for both the option buyer and seller. However, the movement of the underlying share price has an opposite effect on their respective breakeven points.
For the buyer, the breakeven of an option is the strike price plus the premium. On top of this, they need to add the cost of brokerage.
HOW TO CALCULATE THE BREAKEVEN PRICE
Knowing a trade’s breakeven price is important, because it helps us understand the trade’s market assumption (bullish, bearish, or neutral), where we might manage the trade, and provides context around the trade’s probability of profit (POP).
To calculate a trade’s breakeven price, we need to find the underlying price where the trade doesn’t make or lose money.
If the strike price of a call option is $10, and the buyer pays a 50 cent premium, then the breakeven is $10.50. Meaning that the underlying share price has to get to $10.51 before expiry, for the option buyer to make any money.
For long options, the breakeven point is the debit paid past the long option strike price. A long call’s breakeven point is the debit paid above the strike price and a long put’s breakeven point is the debit paid below the strike price. Because we pay a net debit when we buy a long option, the strike must be in the money (ITM) by the same amount we paid for the option to reach the trade’s break-even point. The easiest way to think about this is that when we buy something, we must sell it for the same amount we bought it for to break-even. The only way we can do that at expiration for long options is if the strike price is ITM by the same value that we bought the option for, since we only have intrinsic value at expiration. For this to happen, the stock needs to move in our favor.
long $100.00 call purchased for $9.65
breakeven point = $109.65 ($100.00 strike price + $9.65 debit paid)
long $80.00 put purchased for $1.50
breakeven point = $78.50 ($80.00 strike price – $1.50 debit paid)
With selling options we move the breakeven in our favor. At entering a trade we sell option and receive option premium. This moves the break even price in our favor.
As long as the underlying does not move past your breakeven your profit/loss is positive. It means you can close the position with a profit.