Call Option Payoff Diagrams: Explained
- What are call option payoffs?
- Understanding a call option payoff diagram
- How to interpret payoff graphs
- Payoffs for call option buyers and writers
Understanding Payoffs in Call Options
Buying call options through m.Stock is one of the most straightforward entry points into the world of derivatives. The appeal lies not in unlimited returns alone but in the certainty that potential losses are capped. This balance of risk and reward can be easily visualised using payoff diagrams.
The profit or loss for a call option buyer depends on the spot price of the underlying asset at expiry. If the spot price ends up higher than the strike price, the call buyer makes a profit. If the spot price is lower than the strike price, the option expires unexercised, and the loss is limited to the premium paid.
Visualising the Call Option Payoff
Let’s consider a case where you purchase a three-month Nifty call option at a strike price of 17,000, paying a premium of ₹100.
A typical call payoff diagram illustrates this visually. The horizontal axis represents Nifty's price movement, while the vertical axis shows profit or loss.
- If Nifty rises above 17,000, your call becomes In-The-Money (ITM).
- Once the spot price exceeds strike price + premium (₹17,100), you start making a net profit.
- If Nifty stays below 17,000 at expiry, your option becomes worthless, and your loss is capped at ₹100.
The diagram shows that potential profits are theoretically unlimited, while losses are always fixed.
P&L Snapshot for a Call Option Buyer
On expiry Nifty closes at | CE buyer’s payoff |
16,700 | -100 |
16,800 | -100 |
16,900 | -100 |
17,000 | -100 |
17,100 | 0 |
17,200 | 100 |
17,300 | 200 |
This table assumes a simple 1:1 movement between index price and option premium, which may vary. Still, it clearly demonstrates the breakeven point and how your gains grow once the price surpasses that threshold.
As a call buyer, your:
- Loss zone: Spot price < strike price + premium
- Neutral zone: Spot price = strike price + premium
- Profit zone: Spot price > strike price + premium
Call Option Writers: The Other Side of the Trade
Every call option bought has a seller—or option writer—on the other end. The writer initiates the trade by offering the contract and charges a premium for it.
Simply put, the writer’s loss equals the buyer’s gain. If the market moves above the strike price, the call buyer profits by exercising the option, and the call writer incurs a loss. The higher the spot price goes beyond the strike price, the larger the writer's loss.
- As long as Nifty stays below ₹17,100, the writer retains the premium and makes a profit.
- Above ₹17,100, losses start accumulating.
- Unlike the buyer, the call writer’s losses are potentially unlimited, while profits are limited to the premium received.
This asymmetry in payoff makes call writing a strategy that demands higher capital, market expertise, and risk appetite. The higher the perceived risk, the higher the premium charged by the writer.
Long Call: A Strategy Favoured by Beginners
Call buyers typically enter when confident about a bullish market trend. A long call strategy is ideal for capitalising on upward price movements without committing large capital upfront.
Payoff diagrams help these traders:
- Identify risk-reward zones
- Understand breakeven points
- Visually grasp their exposure
With m.Stock, first-time options traders often prefer long calls due to the simplicity and risk cap they offer.
Key Takeaways
- A call option allows the buyer to profit when the market price exceeds the strike price plus premium.
- The maximum loss for the buyer is limited to the premium paid.
- Payoff diagrams simplify risk-reward analysis and decision-making.
- The call writer earns the premium but faces unlimited loss potential if the market rises sharply.
- Call buying is a low-risk, high-reward strategy for bullish traders, while call writing is best suited for experienced participants with sufficient capital and risk management strategies.