If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains *.kastatic.org and *.kasandbox.org are unblocked.

Main content
Current time:0:00Total duration:4:07

Video transcript

if I were to buy a put option with a $50 exercise price and if I were to buy it for $10 then the value of my position the payoff for that put option at the maturity or at the expiration I should say at the expiration of the option depending on what the stock price is that expiration will look like this if the stock price is worth if the stock price goes to zero then the put option is worth 50 because I could buy the stock at zero and exercise my option to sell at 50 at putting the the stock to someone else at 50 dollars all the way to the stock becomes worth 50 then my put option I wouldn't need to exercise it because why would I it's worthless to have the option to sell something at 50 where you can just sell it in the sell the actual stock in the open market or buy the open or buy the stock at 50 so then the put option becomes worthless for a stock price above that now this is the payoff diagram and this is when we just think about the value at expiration if we think about the actual profit and loss at expiration it would look like this it would just be shifted down by 10 dollars because we have to pay 10 dollars to get this value so if the stock is worth zero the put option itself is worth 50 but I have spent ten dollars to get it so the profit is going to be $40 and so then at 50 I wouldn't exercise the put option so I've lost the ten dollars that I spent on the option so my payoff diagram would look like I want to draw it relatively neatly my payoff diagram would look like this once again this payoff diagram just incorporates the price of the option so it's the actual profit this is just the value at expiration depending on what the value of the stock is at expiration now this is just a situation if you were to buy an option but there has to be someone on the other side of the contract someone who's holding the someone who's agreeing to buy the option for you so you could actually have the writer you could actually have the writer of the put the payoff diagram we just showed is the person who owns the put but someone else had to have created the put they said oh you know what I will give you the right I will give you the right to sell to sell me the stock at 50 dollars up to some expiration date so what does their payoff diagram look like well if this guy is if this guy has is going to be able to make $50 this guy's over here the writer the writer of the foot is going to lose $50 he's going to have to essentially go out he's actually going to have to buy that $50 put or buy that $50 stock from this person because he has to uphold his side of the transaction but he's buying something for $50 it's worthless because based over at this end of the axis the stock would be worth nothing so he's taking a $50 loss all the way to him not having to do anything because the foot holder won't actually exercised their option of death stock price is 50 so their payoff diagram is going to look like this so you can see it's actually the mirror image of the payoff diagram of the person on the other side of the contract and if you were to add these two payoff diagrams you would be neutral because all of the money is exchanging hands between the buyer and the seller of the put if you look at the actual profit or loss if the put is not exercised then the writer of the foot essentially just got a free $10 he sold he sold the put to this guy for $10 she created the foot and sold to that guy he gets $10 the foots not exercised he gets to keep that $10 but then if the stock goes down and he's forced to buy the stock from the owner of the foot he has to buy it because that's his side of the deal that all of a sudden he loses money so he would go if all the way down if the stock is worth nothing he is forced to buy something for $50 it's worth nothing he would take a $50 loss but he made the $10 on the actual price of the of the option so it would be a negative $40 profit and so his pay his profit and loss would look like this but once again these are the mirror images of each other