Options trading is easy to those of us who’ve gotten used to its intricacies, but it can be difficult to grasp for novice traders. This is especially evident when we’re dealing with vertical spreads, condors, and other more advanced trading strategies. One common issue I faced when learning to trade options was visualizing how my trades could go.
For context, just take a look at an options chain - it's all numbers on a screen. Profit and loss charts make trade visualization easier and give you relevant trade information you can use for your choices.
What Are Profit/Loss Charts?
Profit/loss charts are options trading staples that give you a short-hand visualization of the potential outcomes of a trade. They usually look like this:
Even without legends, you can see important trade details such as like maximum profits/losses, breakeven points, strike prices, and more.
Profit/loss charts are particularly effective because they transform complex numerical data into an easy-to-read visual representation, making it simpler to analyze risk and reward. Instead of mentally juggling multiple strike prices and premiums, traders can quickly see how different market conditions affect their trade. This can be especially useful for complex, multi-legged strategies like butterflies and condors.
These charts also help traders compare multiple strategies side by side so they can make the right choice depending on the overall market conditions.
Profit-loss charts can be accessed for certain trades through specific stock or asset pages. To find them, go to an asset page, then navigate to the option strategies on the left-hand pane.
Once there, click on the chart icon, and the profit/loss chart and the Greeks, Expected Move, Volatility, and Trend tabs will appear.
Now, for a working sample of how these charts help, let’s talk about selling credit spreads.
Credit Spreads vs. Naked Options
To many, selling options might seem like a good way to earn money. After all, the premium is guaranteed, and all you need to do is make sure your underlying doesn’t exceed or go below the strike price, right?
Unfortunately, the market is not kind to those who gamble blindly. I’ve seen and heard endless horror stories about selling naked puts for marginal gains against the losses that would bankrupt entire families- we all know of someone who's been affected.
Credit spreads, like bear calls, bull puts, short butterflies and condors, are a good alternatives to selling naked. With these strategies, both your maximum profits and losses are capped.
Example Trade
So, let’s say you want to trade a short iron condor on Meta Platforms with around a 30 DTE (days to expiration). For reference, the short iron condor anticipates the underlying security to trade within a specific price range. The strategy involves:
- Buying a put option, then selling another put option at a higher strike price (bull put)
- Selling a call option, then buying another call option at an even higher strike price (bear call)
The short iron condor combines a bull put spread and a bear call spread, and you receive a net credit at the start of the trade.
Now, if we navigate to the Meta Platforms stock profile page, click Condor Strategies on the left, and then click the Short Iron Condor tab. You can change the expiration date to your preferred period.
Then, the results are automatically arranged by lowest loss probability. Let’s say you choose the top one trade, which is this:
This specific trade suggests trading a short iron condor on META with the following details:
- Buy a $470-strike put for 82 cents
- Sell a $525-strike put for $2.11
- Sell a $745-strike call for 97 cents
- Buy a $800-strike call for 43 cents
Other relevant details are already there, like the breakeven points (BE+ and BE-), the max profit ($1.83), and max loss ($53.17).
Now, if you click on the chart icon for that specific trade, all those details are consolidated into one chart:
How to Use the Profit/Loss Chart in Decision-Making
Like with any intuitive chart, the red areas indicate loss, green indicates profit, and the broken line represents the breakeven prices for the trade. Once you’ve pulled up the chart, here’s how to break it down:
- Breakeven zones: These are visually marked by where the red (loss) turns into green (profit). See how wide the breakeven range is and ask yourself whether the underlying is likely to stay within that zone until expiration.
- Risk vs. reward: The chart makes it easy to compare your maximum gain (flat top of the green area) against your maximum loss (bottom of the red area). Make sure the trade-off makes sense based on your market outlook, though consider that safer trades often have wider profit/loss ratios.
- Volatility expectations: A short iron condor benefits from a decrease in implied volatility; you want to ensure that the current IV is relatively high. If volatility expands instead, your loss potential increases. You can click on the Volatility tab to check.
- Probability of profit: This can be useful for filtering through viable setups, but always cross-reference it with your directional analysis.
Final Thoughts
Profit/loss charts effectively communicate important trade details and outcomes without overloading the trader with information. This can be a great way to introduce someone to options trading and its risks and benefits, though that doesn’t mean they start trading without a deeper understanding of the working principles.
Remember, options trading is not gambling. Tools like Barchart’s Option Screener and the new Profit-Loss Chart feature can help improve your chances of success, but you still need to understand what you’re doing. So, due diligence and market research are still non-negotiable.
