Visual Quantitative Finance: A New Look at Option Pricing, Risk Management, and Structured Securities

9. Adding Options to the Model

The next step in building the model is to complete the options section of the Profit Calculator. The following is a review of the standard profit formulas for options. In the chapters on option pricing, option payoffs were used instead of option profits. The difference is that option profits are adjusted for the premium paid or received. In the following formulas, the stock price at expiration is S and the option strike price is K.

• Long call option: The payoff of a long call option (purchased call option) is given by the expression max{S − K, 0}. The profit is max{S − K, 0} − premium paid.

• Short call option: The payoff of a short call option (written, or sold call option) is given by –max{S − K, 0}. The profit ...