Lesson 6 of 20 · 6 min
How to read a payoff diagram
A payoff diagram plots outcome at expiry against underlying price, and every feature of it means something specific.
A payoff diagram is the standard picture of an option position, and it is genuinely informative once you know what the axes and the kinks are.
How to read one, feature by feature:
- The horizontal axis is the underlying price at expiry, not today's price and not time.
- The vertical axis is profit or loss for the whole position, usually after the premium.
- A flat segment means the outcome does not change over that price range.
- A sloped segment means the outcome tracks the underlying one-for-one in that range.
- A kink sits at a strike. Every strike in the position produces exactly one kink.
- The crossing of zero is the breakeven price, which is a strike adjusted by the premium.
The critical limitation, and it is the reason people misuse these diagrams: a payoff diagram shows expiry only. It says nothing about the value of the position tomorrow, or next week, or five minutes after a volatility spike. A position can be far underwater on a diagram's timeline and profitable today, or the reverse. Before expiry, value is governed by the pricing model in Track 3, not by these lines.
Read the diagram for structure — where are the kinks, is any segment unbounded, where is breakeven — and read the Greeks for behaviour between now and then. The two answer different questions and neither substitutes for the other.
Key terms
- Payoff diagram
- A plot of profit or loss at expiry against the underlying price at expiry.
- Kink
- A change of slope in the diagram. Occurs at a strike, because that is where an option's behaviour changes.
- Breakeven
- The underlying price at expiry at which profit is zero. For a long call it is strike plus premium; for a long put, strike minus premium.
Worked example
Every feature of one diagram
A long $50 call, premium $2.00, one contract covering 100 shares.
- Below $50
- Flat at −$200
- Kink location
- $50
- Between $50 and $52
- Rising, still negative
- Breakeven
- $52.00
- Above $52
- Rising one-for-one, unbounded above
- At $60
- +$800
The right goes unused; the premium is gone.
One strike, one kink.
Strike $50 plus $2.00 premium.
($60 − $50 − $2) × 100
Six features, all readable from the shape: a floor, a kink, a breakeven, a slope, and no ceiling.
Check yourself
A payoff diagram shows a long call position with a breakeven at $52. The stock is at $51 with three weeks to expiry. Is the position losing money?
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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.