contrast,thevalueoftheassetisgreaterthanthestrikeprice,
theoptionisexercised—thebuyeroftheoptionbuystheasset
(stock)attheexerciseprice.Andthedifferencebetweenthe
assetvalueandtheexercisepricecomprisesthegrossprofit
ontheoptioninvestment.Thenetprofitontheinvestmentis
thedifferencebetweenthegrossprofitandthepricepaidfor
the call initially.
Apayoffdiagramillustratesthecashpayoffonanoptionat
expiration.Foracall,thenetpayoffisnegative(andequalto
thepricepaidforthecall)ifthevalueoftheunderlyingasset
islessthanthestrikeprice.Ifthepriceoftheunderlyingasset
exceeds thestrikeprice, thegross payoff is thedifference
betweenthevalueoftheunderlyingassetandthestrikeprice,
andthenetpayoffisthedifferencebetweenthegrosspayoff
and the price of the call. This is illustrated inFigure A12.1.
FIGURE A12.1Payoff on Call Option
Aputoptiongivesthebuyeroftheoptiontherighttosellthe
underlyingasset atafixedprice, againcalledthestrikeor
exerciseprice,atanytimepriortotheexpirationdateofthe
option.Thebuyeroftheoptionpaysapriceforthisright.If