Break even

The break-even point on an option is the price that the underlying asset has to hit in order to enable the option buyer (holder) to recover their premium.

So if a call option has a strike price of £2.50 and the up-front premium paid is 50p, the underlying share needs to rise to £3 (ignoring dealing costs and spreads) to hit breakeven. That’s because the holder could then buy the share from the option writer for £2.50 and sell it on in the stockmarket for £3.

However, the 50p profit simply recovers the premium paid. Note that the option is ‘in the money’ as long as the underlying share is priced anywhere above £2.50. If it is, say, £2.70 on expiry, the option should be exercised to reduce the holder’s 50p initial loss.

• See Tim Bennett’s video tutorial: What are options and covered warrants?

Merryn

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