- 1 What is a Payoff Chart?
- 1.1 Axis in Detail.
- 1.2 Uses of Payoff Graph / Profit and Loss Graph?
- 1.3 Payoff Chart of Long Position of Nifty Index or Stock Position
- 1.4 Payoff Chart of Short Position of Nifty Index or Stock Position
- 1.5 Payoff Chart of Hedged Position of Nifty Index or Stock Position
- 1.6 Payoff Chart of Strangle of Nifty Index or Stock Position
What is a Payoff Chart?
A graphical representation of the possible profit and loss of a options or options strategy or options portfolio at any given point in time. In other words, it is a diagram to evaluate how the profit and loss of a position would perform over a range of prices. This is used by basic to professional traders to understand the position and evaluate the risk to reward situation at a glance. Evaluation & estimation of profit and loss also becomes very easy.
There are many ways to accelerate your Learning Curve for Options Trading payoff chart is one of them.
Axis in Detail.
The Y-axis or the vertical axis represents profit and loss for the strategy.
Any point on y-axis above the x-axis is Profit.
Any point on y-axis below the x-axis is Loss.
Now the X-axis represents the price of the underlying such as stock, index or ETF or whatever the underlying g you are trading. Since the stock, index and underlying cannot go below zero hence the graph ends by this.
Any person over a period of time will understand and use the chart in a very natural way. Initially, it might seem very complex but once you are used to it would be an essential tool for options trading.
Professional traders who have a position in multiple option trading strategies plots the entire strategy on a single chart to understand how their positions are and calculate the entire risk to reward ratio. Options Greek is another way to manage.
Uses of Payoff Graph / Profit and Loss Graph?
- Pictorial presentation of the scenario.
- Instant Risk to Reward analysis
- Simple presentation of complex strategy.
- Analysis of the situation and how to adjust if need be.
- Visualization of the Risk.
Payoff Chart of Long Position of Nifty Index or Stock Position
This is a very simple chart to understand the price at which the underlying is bought and above that point, it shows in green and below is shown in grey which is the loss area.
To understand the even more simple term as the price of the stock goes we would get more profit and as the price of the stock goes down we will get the loss. In theory, there is no upper limit and the downward limit is limited to zero.
Payoff Chart of Short Position of Nifty Index or Stock Position
Once you have understood the long position chart the short would be exactly the opposite of the long position. The price at which it is shorted above that at any point it would be a loss. In this case, the loss in unlimited in theory because the price of the stock can keep going up. At the same time now the maximum lowest point the price of the underlying can go is zero.
Payoff Chart of Hedged Position of Nifty Index or Stock Position
A hedged position such a Bull call spread would have limited profit and limited losses. Its a vertical spread with same expiration dates but different strike prices. Here the underlying in Nifty Index and the range here is 9000 to 9200 to stay profitable and the maximum profit is around Rs. 10000. At the same time if the index goes below 9000 to any point maximum loss would be around Rs. 5000.
A hedged strategy is used by professional traders since the profit is limited and at the same time losses are also limited. Professional traders maintaining a options portfolio would use this because of many advantages of this strategy.
Payoff Chart of Strangle of Nifty Index or Stock Position
Short strangle diagram looks like the one below. As far as the underlying stays between this range in this case 8250 and 9500 the strategy would be profitable. Once any of the range is broken then it would lead to unlimited losses. Strategy identification and application would be easy with the understanding of the payoff diagram. Every strategy would have its own payoff diagram.
Credit of Payoff Charts – Upstox
In short payoff, a chart would enable one to understand the risk associated with a particular strategy. Based on your objective one should consider and understand all the risk that is associated with the strategy prior to making an investment decision. It is very important to match the risk profile along with investor expectations for ideal options portfolio allocation.
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Come back here and tell us about your experience before understanding the payoff chart and after understanding the payoff chart. I bet you’ll have something to say!
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Also published on Medium.