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Education / Track I · Foundations / L.02

Calls, Puts, and Payoff Diagrams

Four primary positions, four payoff shapes. Once you can draw these from memory, every other strategy you will ever encounter is a recombination of them.

14 min read · Lesson 2 of 24

Why payoff diagrams matter

A payoff diagram shows what a position is worth at expiry, plotted against where the underlying ends up. The horizontal axis is the price of the underlying. The vertical axis is your profit or loss. Once you can sketch the four primary diagrams from memory, every multi-leg strategy becomes a sum of pieces you already know.

Four primary positions exist: long call, long put, short call, short put. Each has a distinct shape. Each has a distinct risk profile. Walk through them in order.

Long call

You buy a call with strike $100 for a premium of $4. If the stock ends below $100 at expiry, the call is worthless and you lose the $4. If it ends above $100, the call pays one dollar for every dollar the stock is above $100. You break even at $104. Above that, your profit grows one for one with the stock.

$100 0 +$50 −$20 Underlying Price at Expiry P&L per Contract Strike $100 BE $104 Long Call · Strike $100 · Premium $4
Fig. 02.1 Long call. Loss is capped at the premium. Gain is unbounded above the strike.

This is the cleanest shape in the options world. Limited loss, open-ended gain. You buy this when you think the underlying will rise, and rise enough to cover the premium plus generate real profit.

Long put

You buy a put with strike $100 for a premium of $4. If the stock ends above $100, the put is worthless and you lose the $4. If it ends below $100, the put pays one dollar for every dollar the stock is below $100. You break even at $96. The maximum gain is bounded only by the stock going to zero.

$100 0 +$50 −$20 Underlying Price at Expiry P&L per Contract Strike $100 BE $96 Long Put · Strike $100 · Premium $4
Fig. 02.2 Long put. Loss is capped at the premium. Gain grows as the underlying falls toward zero.

Buy this when you think the underlying will fall, or when you want insurance on a long stock position. A put on a stock you own is the financial equivalent of an insurance policy. You pay a premium. If the stock crashes, the put pays out and offsets your loss.

Short call

You sell a call with strike $100 and collect a premium of $4. If the stock ends below $100, the call expires worthless and you keep the full $4. If it ends above $100, you owe one dollar for every dollar the stock is above $100. You break even at $104. Above that, your loss grows one for one with the stock, with no ceiling.

$100 0 +$20 −$50 Underlying Price at Expiry P&L per Contract Strike $100 BE $104 Short Call · Strike $100 · Premium $4 received
Fig. 02.3 Short call. Gain is capped at the premium received. Loss is unbounded above the strike.

This is the most dangerous primary position. Selling a naked call (without owning the underlying as a hedge) means accepting unlimited loss for a fixed gain. Most retail brokers will not let you do this without elevated permissions, and for good reason.

Short put

You sell a put with strike $100 and collect a premium of $4. If the stock ends above $100, the put expires worthless and you keep the $4. If it ends below $100, you owe one dollar for every dollar the stock is below $100. You break even at $96. Maximum loss happens at zero, where you owe $96 (less the $4 premium, so $92 net).

$100 0 +$20 −$50 Underlying Price at Expiry P&L per Contract Strike $100 BE $96 Short Put · Strike $100 · Premium $4 received
Fig. 02.4 Short put. Gain is capped at the premium received. Loss is bounded by the strike going to zero.

Selling puts is how option sellers get paid for taking on risk. The economic interpretation: you are agreeing to buy the stock at $100 if it falls below that level, and you are getting paid $4 to make that promise. If you wanted to buy the stock at $100 anyway, this is a way to get paid for waiting.

The symmetry

Calls and puts are mirror images. So are long and short positions. Put the four diagrams next to each other and the symmetry becomes obvious.

The four primary shapes
Long call: bounded loss, unbounded gain. Long put: bounded loss, large bounded gain. Short call: bounded gain, unbounded loss. Short put: bounded gain, large bounded loss. Every multi-leg strategy is a sum of these four shapes.

Putting them together

Every spread, condor, butterfly, calendar, and ratio you will encounter in later lessons is a combination of these four primitives. A bull call spread is one long call plus one short call at a higher strike. An iron condor is a short call spread plus a short put spread. The shapes add.

This is why fluency with the four primary diagrams matters. If you can sketch each one from scratch, you can build any multi-leg payoff by stacking the components. If you cannot, you will spend the rest of your options education looking up payoff charts in books.

What you carry forward