How do I stop mixing up option payoff and option profit on CFA derivatives questions?
I can usually tell whether a call or put is in the money, but I still lose points because I answer with payoff when the question wanted profit. Is there a fast way to separate the two under time pressure?
Use a two-line routine every time:
- Solve expiration value from intrinsic payoff only.
- Then add initial premium inflows and outflows to reach profit.
Suppose Aster Telecom buys a call with strike 40 for premium 3. If the stock ends at 46:
- Expiration value =
46 - 40 = 6 - Profit =
6 - 3 = 3
If the question says "value at expiration," stop at 6. If it says "profit," keep going to 3.
The clean mental shortcut is that payoff answers the question "What is this position worth at expiration?" Profit answers "After I account for what I paid or received upfront, how much money did I make?"
Candidates often know the option formula but still skip the premium adjustment. That is why writing value first, profit second on scrap paper can save an easy point.
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