Question

The spot rate of gold is $1,200 per ounce. Please plot the payoff of buying a call option on an ounce of goldwith a $50premium and the strike price equal to $1,200.

Answer 1

A Call option gives you the RIGHT, but not OBLIGATION, to Buy the underlying security at the given strike price. Therefore a call option's intrinsic value or payoff at expiration depends on where the underlying price is relative to the call option's strike price.

Now, in the given case the spot rate as well the strike price of gold is $1200 per ounce. The premium on the same is $50. So, call option will lapse if price of gold at expiry is $1,250 or less. (includes $50 of premium)

So if at expiration of option, the price of gold is $1,300 then the payoff on the option is $50 (1300- 1200 - 50).

If at expiration of option, the price of gold is $1,100 then the payoff on the option is nil (1100- 1200 - 50 i.e -150).

The payoff table on the same is given below:

Price of Gold on expiry (in $)	Exercise/ Lapse	Payoff (in $)	Initial Cost (in $)	Net Profit (in $)
1,100	Lapse	0	50	-50
1,200	Lapse	0	50	-50
1,250	Exercise	50	50	0
1,300	Exercise	100	50	50
1,400	Exercise	200	50	150

Payoff graph of the above table is given in the attached image.