I understand that premium pricing is dependent upon a few factors like intrinsic price and time value, the latter being affected by volatility. But as I look at my risk profile in thinkorswim on a given single leg call, I'm having a difficult time getting my head around the concept of differing P/L at date of exercise. See the below screen capture:

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As those of you familiar with thinkorswim know, the purple line is my P/L if I were to exercise today. The blue line is my P/L on the date of expiration. I'm having a difficult time with this concept. I appear to be fundamentally misunderstanding how premium pricing works.

Does the premium increase/decrease even after I've bought the option? If so, it appears the the premium increases as we approach expiration, cutting into P/L. But if that's the case, then why does the premium never go above the initial $975 paid per contract?

Can someone explain what's happening here?

  • Ok, so I think looking at what happens if I exercise today at the strike price is a helpful way to think about this. I break even in that case because the price of the premium is the exact same price I bought at. And since the price of the option increases as we approach expiration, we need the underlying to increase more and more to make a profit. I suppose I didn't realize that the premium rises on an option I've bought. – J. Adam Connor Jan 16 at 20:26

An option's premium is primarily dependent on the price of the underlying, the amount of time remaining until expiration and the implied volatility (not the volatility of the underlying).

Note that neither the purple or the blue line is the call's price. It is the amount of your call's profit or loss for today based on a price range of $30 to $90 for PLUG.

Yes, the blue line is your P/L on the date of expiration. Your long call gives you the right to buy the stock at the strike price. Since your call's strike price is $62.00 and since you paid $9.75 for the call then your acquisition price will be $71.75 should you exercise your call. That is why the blue line is just short of -$1,000 below $62.00, reaches your break even at $71.75 and then as PLUG rises, you make $1 for every $1 that PLUG rises (there is no time premium at expiration).

The purple line is a today's depiction of the P&L of your call should PLUG move up or down today. It shows a break even on the graph because it's reflecting the purchase price today of $9.75 which does not take into account the wide spread which I think is due to stale after hours quotes. It would take a drop to about $30 to make your call almost worthless. The purple line will change every day based on time decay and change in implied volatility, getting lower and lower until it approaches the blue line at expiration.

I would suggest that you if you want to understand options, pick up a copy of "Options as a Strategic Investment" by Lawrence G. McMillan. There are other good books as well but this one will give you a sound understanding of the mechanics of options and different option strategies.

  • Excellent. Thanks for the book suggestion. I’ll definitely pick it up. – J. Adam Connor Jan 16 at 22:35
  • Just got the book. Thanks again for the suggestion. The issue I think with learning about this isn’t so much a dearth of information as an abundance. There is just so much noise primarily from apparent hucksters that it’s a little overwhelming. I’ve relied mostly on investopedia so far, but a single reliable source for both a novice to advanced understanding is exactly what I’m looking for. – J. Adam Connor Jan 16 at 22:46
  • It's a lot of bad noise. Hucksters hype performance and often offer misleading info. And while Investopedia is generally a good source of info, there are occasional bad articles. A novice doesn't have the ability to recognize this so there's a lot of off on useless tangents. 30+ years ago I spent a summer by the pool with the first edition. It fried my body and my mind but eventually it sank in and over time I've been able to flesh out what I wanted to do and felt comfortable with. I'd advise you to trade minimally until you grasp more. I didn't at first. Good luck. – Bob Baerker Jan 17 at 1:25

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