HOW PAYOFF DIAGRAMS WORK

Plain English

Think of a payoff diagram like a road map for a road trip. The horizontal mile markers are possible stock prices on expiration day. The vertical elevation markers show your cash position: above sea level is profit, below is loss. Your strategy is the route line — where it climbs you make money, where it dips you lose. Knowing this map lets you decide whether the journey is worth the gas and whether the mountains of risk are too steep before you ever put the car in drive.

Going deeper

A payoff diagram plots P(S_T) on the y-axis (dollars of profit or loss at expiration) against every possible stock price S_T on the x-axis. For a single long call purchased for premium C with strike K: P(S_T) = max(0, S_T − K) × 100 − C × 100. Below K the option is OTM, intrinsic value is zero, and the graph is a flat line at −C×100 (max loss). At S_T = K + C the line crosses zero — the expiration breakeven. Above that, profit rises one-for-one with the stock. For a credit spread, the diagram has a flat profit region, two slope segments, and two flat loss regions — the 'tent' shape. For a long straddle, the diagram is V-shaped with the vertex (max loss) at the strike and profit extending in both directions beyond the breakeven prices. Reading payoff diagrams quickly tells you: max loss, max profit, breakeven(s), and directional bias at a glance.

Examples