Simply put, Profit/Loss Chart (PLC) is the easiest and quickest way to understand your strategy to make profit. It can be used in any kind of trading, but it’s commonly use to illustrate option trading strategy (which can be complex, but then become easier after seeing the PLC). Just with simple glance, you can see from PLC: your break even point, where is your maximum profit, when you start losing money, when you start making money. Or in other word, what need to happen with the price for you to make profit.

Remember in share market related trading (including option trading), if the price go up it does not mean that you always make money. All depends on the strategy. Some strategy requires the price to go down in order to make profit. Other strategy will produce profit if the price goes up.  Another strategy make you money only if the price stays the same. Because of this, the Profit Loss Chart (PLC) become very useful tools. Let’s have a look more detail.

The PLC Chart

On the left is a graph that contains a PLC. The vertical line/axis on the left represents the profit (or loss) – it’s a profit if it’s above zero, it’s a loss when below zero. The zero is where the horizontal line intersects.

The horizontal line/axis represents price. Go to the left is lower price. Go to the right is higher price.

The notch on the horizontal line is initial price (the price when we start do the trading)

The blue line is the Profit Loss Chart/PLC itself.

Let see a little bit more detail about the graph and how we interpreted it into an elegant understanding.

• The green area is profit area
• The red area is loss area
• The starting price is $20
• The breakeven is on $25
• If the price at $30 there will be profit of $200
• If the price is less than $20 there is constant loss of $100
• So, when we start at $20, we immediately at loss position ($100 loss). That ‘loss’ is due to the capital cost (buying the option), brokerage cost, or other cost.
• If the price keep going down, luckily, we don’t make additional loss (the blue line on the left of $20 is on loss area)
• If the price going up from $20 to $25, we are getting to the break even point
• Only if the price is higher than $25, we are on profitable area. If it’s $30 then it’s $200 profit.
• So, from all of those point we can conclude that this kind of trading is bullish, meaning it needs the price to go up in order to make money, but it’s protected from the downturn (not making any more loss)
• This PLC is real one. It’s the PLC for buying call option.

So, just by looking this simple picture, a lot can be derived from it.

More Examples

Let see some more examples:

• When we start, immediately we are in profit already. (This will be refered as ‘credit’ strategy – since it start with some credit (money) in the pocket).
• If the price go up, it will give some additional profit only until certain price and it will go flat (no more additional profit.
• If the price go down, it will go down proportionally with the price
• So this strategy need the price to go higher just a bit to maximize the process, but we will make a loss if the price go down
• This is a strategy named “Buy Write” (or also known as “Covered Call” or “Share Renting”)

• When we start, we slightly in a bit of loss. (This could be due to some brokerage cost or other cost)
• If the price go up the profit also go up proportionally
• If the price go down the profit also go down proportionally
• We will reach break even point if the price just go up a little
• So this strategy need the price to go higher (bullish strategy) in order to make profit/
• This is the PLC for normal stock trading

• When we start, we are at the peak of our loss
• The profit go up when the price go up
• Also , the profit go up when the price godown
• In other word, as long as the price move from the starting point, doesn’t matter go up or down, we will start making progress toward profit. We just want the market to move the price. Usually this is good for a volatile market
• This is the strategy call “Straddle”. This strategy involves buying both put option and call option at the same strike price.

• When we start we are at the maximum profit.
• If the price go down, the loss will increase as well but it will be capped (no more loss after reach certain loss)
• If the price go up, it will not change any profit
• The break even is reached if the price go down a little bit.
• So this strategy also require the market to go up in order to maintain the profit (bullish strategy)
• This is a strategy called “Credit Bull Put Spread”. This involves writing put option near or at the money and buying another put option further out of the money.

• When we start, we are at the peak of our loss. This is due to cost that incurred at the start of the trading, including brokerage cost and the capital itself.
• If the price go up, the loss stays the same (increase in price will not putting more loss)
• If the price go down, the profit is increasing proportionally with the price
• The break even is also reached if the price go down a little bit.
• So, this strategy requiring the market to go down in order to make profit (bearish strategy)
• This is PLC for buying put option

Conclusion

The Profit Loss Chart is handy tool to see whether a strategy is requiring a down market, up market or neutral market. It can show elegantly where the maximum profit is, when we start losing money as well as the break even point.

Denis Kristanda