Up to now, we only focussed on buying a put- or call option. However, instead of going long in these products, a trader could also short either option. By shorting the option, the pay-off diagram will be mirrored around the x-axes and the trader is then betting against the product.
Consider a call option. The price that the trader pays for the option will from now on be called the premium. Let’s consider the case that the trader buys the call option, so in other words, the trader is long in the call option. In case the option does not end up ITM enough (so that the trader breaks even with the premium), then the trader has a negative profit and loss (P&L) balance. However, if he would have shorted the call option, this balance becomes equally positive. Let’s draw both pay-off diagrams, for being long in a call option and being short in a call option.
Figure 1 and Figure 2 showed both the P&L at the expiration date and the P&L three months prior to the expiration date. From now on, pay-off diagrams will show the P&L at the expiration date. Figure 3 and Figure 4 illustrate the pay-off diagrams for the long put option and short put option, respectively.
These four pay-off diagrams lay the foundation for some of the well known option strategies. Remember that traders call the market a long-market when the prices are in a uptrend and bear-market when the prices are in a downtrend. The following strategies will be discussed.
