Diagrams

Draw diagrams to show the profit or loss at expiry as a function of the underlying asset
price for:
A) the holder of a call option
B) the writer of a put option
C) the buyer of a futures contract
D) the seller of a futures contract
Label your diagrams appropriately.

My problem with the above question is that I am unable to understand on what basis should I make the diagrams.

 

Hi

Without referring to the section of the course you refer (many of us on this platform would have studied this some time ago so won't have access) I suspect the question is attempting to get you to think about the payoff profiles of the various derivatives.

As a hint/example:
Taking A) the holder of a call option
If you hold a call option you have the right but not the obligation to take possession of the underlying (e.g. the stock of Apple) within a particular time period, say a month.

In exchange for paying an option premium to the writer you therefore have the following payoff profile max{S(t) - K,0}

As you can see you will ONLY take possession of Apple stock if the price exceeds some price K.

On the horizontal axis you will have the price of the underlying and along the vertical axis you will have profit/loss.

The 'trick' is to think about what you would do if

i. The price was below K
ii. The price was above K


Then think similarly for the obvious solutions.

For B) the writer of a put option the payoff profile is -max{K-S(t),0} . Can you think why? I've alluded to above

 

Duuno, how about profit/loss (y) vs price of asset (x), marking all significant points and limits?

 

Thanks to all those who replied.

This question is from an Indian CT2 paper in recent years.
I guess i should abandon this question and not pay much attention to it.

Thanks anyways to all.