How to Calculate the Break-Even Point in Options
Options are contracts that entitle you to buy or sell a specified amount of a security, such as shares of a company's stock, at a predetermined "strike price." Calls are options to buy. If the market price of the security goes up, you can exercise (use) a call option to buy at the strike price. You resell the security at market, making a profit. Puts are options to sell. With puts, you make money if the security falls in price. You buy the security on the market. The option writer (issuer) must buy the security at the higher strike price when you exercise the option.
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Instructions
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Compute the intrinsic value the option had when you bought the contract. For call options, intrinsic value is the difference between the strike and market prices if the market price was higher than the strike price. If the market price was equal to or lower than the strike price, the intrinsic value is zero. For puts, intrinsic value equals the difference between strike and market prices if the strike price was higher than the market price. Otherwise, the intrinsic value of the put option is zero.
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Figure the total price you paid for the option. The total price is equal to the intrinsic value plus the fee charged by the option writer. This fee may be called the premium or the extrinsic value of the option. To find the total price, just add the intrinsic and extrinsic values together.
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Add brokerage commissions and any other transaction fees to the total price you paid for the option. This gives you the total cost of the option.
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Add the total cost of the option to the strike price for call options to find your break-even price. For put options, subtract the total cost from the strike price to calculate your break-even price.
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Tips & Warnings
Strictly speaking, the term premium refers only to the fee charged by the option contract writer. However, you'll often see the total price of an option contract referred to as the premium. If you aren't sure exactly what is meant in a particular situation, don't hesitate to ask your broker.
