Call options are financial instruments that give the holder the right, but not the obligation, to buy a financial security, such as a stock, at a predetermined date and price. Put options give you the right to sell an asset. Call options appreciate in value as the asset they are tied to appreciates in value, while put options are worth more if the asset depreciates. Understanding at what point you will recover what you paid for the option and break even is the first step in evaluating an option trade.
Determine Option Cost
Find out how much you paid for the option that you want to calculate a break-even point on. To find the price, go over your account statement or list of trade confirmations. Next, add the commission you paid to purchase the option. If the option price was $300 and your broker charged $30 in commissions, your total cost is $330. If you purchased the option in several installments, add up all purchase prices and commissions. The first lot may have been a call option for 300 shares of Company A, while the second lot may have been for an additional 200 Company A stocks. If these options are identical, you can add up their costs to determine your total expense for options granting you the right to 500 Company A shares.
Cost Per Share
Divide the total cost of options, including commissions, by the number of shares that the option gives you a right to buy or sell. You can find the number of shares that an option is for in your list or table of trade confirmations. If, for instance a call option allows you to buy 300 shares of Company A and it cost $330 in total, the cost per share is $330 divided by 300, which equals $1.10 per share. This step is identical whether you are calculating the break-even point for a call or put option.
If you are looking at a call option, add the cost per share to the option's strike price. The strike price is what you must pay per share if you elect to exercise the option. A call option that allows you buy 300 Company A shares at $30 each has a strike price of $30. Add your option cost per share to this strike price. In our example, the cost was $1.10; adding this to the strike price results in $31.10. This is the price that Company A stock has to reach for you to break even. If the price of Company A stock exceeds this level, your call option will yield more profit than you paid for it and result in a net gain.
For a put option, subtract the net cost per share from the strike price. If your put option allows you to sell Company A at $30 and your option cost per share is $1.10, your break-even point is $30 minus $1.10, which equals $28.90. The stock of Company A has to decline to that level for you to breakeven. Should the price of the company's shares decline below $28.90, you will register a net gain.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.