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Current time:0:00Total duration:3:48

Video transcript

let's think about the payoff diagram for just owning the stock or we could say going long the stock which is really just owning it if we think about just the underlying asset value and we're talking about the value at some date and you know when traditionally we're talking about some maturity date for some options but the value at maturity but it's some date we have in our mind so the if we're thinking about just the value if on that date the underlying stock price is 50 then the value of holding the stock is going to be 50 if the if the value of the underlying stock is zero then the value of owning stock is going to be zero if the value of the underlying stock is 70 then the value of the stock is going to be 70 so you just have this very simple line payoff diagram it's just whatever the underlying stock price that is the value of the asset because you just own the stock if you think about it from a profit-and-loss point of view you break even if on that day since you're paying $50 per share for it today if on whatever date we're talking about the stock price at some future date at maturity for some for some type of option you paid 50 if the value is 50 then you're at breakeven if the value is at zero then you just lost $50 so your going to be at negative 50 over here if the value of the stock price on that days goes to 60 70 80 90 100 then you just made $50 so it's going to be this point right up here the your profit will be 50 so you see a payoff diagram that looks something like this and once again the only difference between this payoff diagram and that bet payoff diagram is that this one right here is shifted down by $50 to incorporate the price that you paid for it now let's say this is what happens if you just buy the stock and let's say you want to buy the stock but you want to mitigate your downside risk you want to buy some insurance on your stock you want to mitigate the downside so what you can do is you can literally just also buy a put option maybe with a strike price right at 50 you want to mitigate your down your downside if the stock goes below 50 and if you do that and I'll only do it on this payoff diagram you could just shift it down for this one what would it look like well just the put options payoff diagram looks like this we've already drawn let me try to do that in the color of the put option we've already done that in a previous video it looks something like this if the underlying stock price is then the put options worth 50 because you can buy it for zero buy the stock for zero and then you have the right to sell it for 50 and then the value of the put option it's worthless if the stock can actually be sold for 50 then you wouldn't exercise the put option but what happens if you own both if you own both at maybe the maturity of the option if the stock is worth zero your stock part is worth zero but the options worth 50 so the combination is going to be worth 50 if the stock is worth 25 if the stock is worth 25 then the put option is also worth 25 so if you own both of them the combination is going to be worth 50 if the stock is worth 50 the put option is worth 0 you own the combination it's going to be worth 50 anything above 50 the put option is just worth 0 but then you have the value of the stock so the stock plus the put would look like this payoff diagram would just look like this payoff diagram right over here so when you look at this what happened is we'll get all of the upside if the stock goes above 50 but we've mitigated our downside this is this right here is the stock plus the put option and what you see here is that the foot is acting as insurance when people talk about buying insurance on a position they're usually talking about buying a put option and of course when if we were to draw the same graph over here we would shift it down by the amount you pay for the stock and for the ten dollars that you're paying for the put option so you would shift this graph down by $60 because that's what it did pay what it cost to go into this position