Long Call (Bullish View): A call option gives the buyer the right to buy the underlying asset at the strike price specified in the option contract.
Profit and loss are calculated this way:
If upon expiration, the underlying/spot price exceeds the strike price, he makes a profit equal to the difference of spot-strike price. Higher the spot price higher the profit he makes.
If the spot price of the underlying is less than the strike price, he lets his option expire un-exercised. His loss in this case is the premium he paid for buying the option.
Let us take an example of Nifty here and draw the payoff diagram. We are considering a strike price of 8600. We then move forward and assume what if nifty expires at a price higher or lower than strike price and the profit or loss a buyer makes.
|Call Option Strike (K)||Nifty at Expiry (S)||Payoff
|8600||8200||0||-50||0-50 = -50|
|8600||8300||0||-50||0-50 = -50|
|8600||8400||0||-50||0-50 = -50|
|8600||8500||0||-50||0-50 = -50|
|8600||8600||0||-50||0-50 = -50|
We can observe from the above table/diagram that a buyer is in profit if Nifty expires above 8600(strike price). He is in loss if Nifty expires at or below the strike price of 8600.
The maximum loss that the option buyer has incurred is the premium paid by him i.e. 50 rupees. And the profit in this case is unlimited or to the extent of the difference between (spot-strike price)
Short Call (Bearish View): A Short Call is also known as selling a Call option. A writer/Seller sells a call option if he is bearish on a stock/Index i.e. if he anticipates that the stock/index may fall in future.
In this case a seller receives a premium upfront from the buyer. If everything goes in favour of the seller, i.e if stock/index falls in the future the maximum profit for a seller would be the premium received. Whereas, if stock/index rises the seller bears an unlimited loss.
Let us see this with an example
The seller is selling a Nifty call option with a strike price of 8600. We then move forward and assume what if nifty expires at a price higher or lower than strike price and the profit or loss a seller makes.
|Call Option Strike (K)||Nifty at Expiry (S)||Payoff = -Max((S-K),0)||Premium||Net Payoff|
As observed in the above table, if nifty expires at or below the strike price, the maximum profit the seller makes is the premium i.e. 50 rupees. Whereas if Nifty expires above the strike price, he makes a loss equal to the difference of strike and spot (strike-spot). Higher the Nifty moves, the higher is his loss.