Risk Graph

What Is a Risk Graph?

A risk graph, otherwise called a profit graph, is a two-layered graphical representation that shows the scope of profit or loss opportunities for a options trade.

Understanding a Risk Graph

The horizontal hub of a risk graph addresses the price of the underlying security at expiration and the vertical pivot addresses the likely profit/loss. Frequently called a profit/loss diagram or p&l graph, this graph gives a simple method for understanding and picture the effects of what might befall an option under different circumstances.

Risk graphs can be drawn to show the likely adjustments for single options as well with respect to spreads or combination strategies. Risk graphs can likewise be developed for short positions, or for complex strategies, for example, butterflies, rides, condors, or vertical spreads.

Risk Graph Examples

The risk graph below shows the profit or loss potential for a simple long call position of ABC Corp with 60 days until the expiration date, a strike price of $50.00, a contract size of 100 (shares), and a cost (premium) of $2.30 per share (for an initial outlay of $230 total).

Notice that the graph incorporates three distinct curves, every one of which address the profit/loss prospects at three unique points in time. The spotted line is the profit/loss today, the semi-dabbed line is the profit/loss 30 days from today, and the strong line is the profit/loss on the expiration date (60 days from today).

As may be obvious, over the long haul, the time value of the option diminishes until it arrives at zero, at which point the option-holder has a maximum loss of $230 (the cost of the option contract), which would happen in the event that the option isn't [exercised](/work out). In this way, utilizing these types of graphs, an option-holder can without much of a stretch view their possible profit/loss at or before the expiration date.

Likewise notice the green vertical line at $50.00, addressing the strike price of the option, which forms an inflection point in the curve. In the event that the option terminates when the underlying ABC stock is under $50, the option will lapse worthless and the investor will lose the premium paid ($230 on the whole). On the off chance that the stock completions somewhere in the range of $50 and $52.30, the trader will lose a portion of the premium paid. Above $52.30, the investor has unlimited profit potential.

The risk graph below shows the expected settlements for a 50 - 55 long call spread (otherwise called a bull vertical spread) in KC futures, where both the possible profit and loss from the strategy are capped.

Features

• Risk graphs can likewise be utilized to show expected profits for spreads, combination strategies, and more complex trades too.
• A risk graph (or profit graph) is a two-layered graphical representation that shows the scope of profit or loss opportunities for an options trade.
• The horizontal pivot of a risk graph shows the price of an underlying security at its expiration date, while the vertical hub shows expected profit or loss.