Cheat Sheet No. 31: Hockey Sticks

Visualize the possible gain or loss from any options trade

By James Blakeway

Simple graphical representations called hockey sticks show the potential profit and loss of any options trade. The name comes from the shape.

Imagery aside, keep in mind that options have a limited lifespan and expiration date. Volatility and time until expiration can change the pricing and profit or loss before expiration. The horizontal axis shows the potential stock price, while the vertical axis represents profit and loss. Remember that options control 100 shares, so options prices can be shown per share or per 100 shares.

Consider a few simple examples of how investors might use options to create a bullish position in Alphabet (GOOGL).

Long call

Investors hoping for a large rally in a stock might purchase a call option with a strike price at, above or below the current price.

In the example with Alphabet trading around $93, consider the potential profit from purchasing a 95 call for $485 ($4.85 debit x 100 shares), which entitles the owner to purchase 100 shares at $95.

The hockey stick shows the strategy won’t make money (at expiration) unless the stock is above $99.85 ($95 + the $4.85 paid for the call), making it a low-probability trade.

Above that breakeven price, the long call makes $100 for each $1 rise in Alphabet. The maximum loss is the $485 cost of the option.

Short put

The short put options strategy, using a strike below the current price, is a higher probability strategy but has a maximum profit of the sale price of the option. This is represented by the flat green portion of the hockey stick. Using the example of selling an 80 put in Alphabet with the price around $93, the premium is $118 ($1.18 x 100 shares).

The strategy makes money as long as Alphabet stays above $87.82 ($89 – $1.18), where the green turns to red on the sloped line. The maximum loss for the trade would occur if the stock went to zero—a fairly unlikely scenario for Alphabet in one or two months.

Short put spread

A hockey stick clearly shows the defined risk and defined profit of a short put spread. Consider the sale of the 90 put and the simultaneous purchase of the 85 put for Alphabet.

The spread is sold for $154 ($1.54 x 100 shares), which is the maximum profit. The maximum loss is the width of the spread minus the max profit [($5 – 1.54) x 100] = $346 loss.

Source for all charts: tastytrade