Next, let's look at the intrinsic value of call options (St - X). I choose calls over puts because they have similar profit characteristics to longs with "downside protection". A call option is the option to "call" (purchase) a stock at a given price (the Excise price, X).
If the market price of the underlying asset is less than X, the call option is worthless (why use a call to buy an asset at a price higher than what you can get it for in the market?). So for any price below X, the value is zero. For each dollar beyond the strike price, the intrinsic value goes up a dollar.
In a Long Call position, the holder pays the premium to the counter party so therefore the entire graph shifts down by the amount of the premium.
It's profit profile for a long position is as follows:
Long Call Profit = (St - X) - Call Premium, while St > X- Call Premium, otherwise
Break Even point, St when Long Call Profit = 0
St = X + Call Premium
Now let's look at the short call position. Remember that between any two opposite positions (Long and Short) the graph is reflected against the X-axis (reflecting a zero-sum game profit between two parties - you can't make something from nothing).
So inversely, being short a call means that you get the call premium, but can lose money if the market price goes up. And the profile is as follows:
Short Call Profit = Call Premium - (St - X), while St > XCall Premium, otherwise
Break Even point, St when Short Call Profit = 0
St = X + Call Premium
A few quick notes:
Notice that a premium is required so that both Long and Short positions have both a profit and loss scenario. If either position doesn't have a profit scenario, then no party will not enter into that position. However, the profit scenario of one becomes the loss scenario of another.
The Break Even point is the same for Long and Short positions (no one comes out on top).
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