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CFA Level I Exam · Pricing and Valuation of Options

Option Payoffs and Moneyness for CFA Level I

Updated 7 October 2026 · Fact-checked

An option payoff is its value at expiration: a call pays max(0, S − X) and a put pays max(0, X − S). Profit is payoff minus the premium paid for the buyer, and the reverse for the seller. Moneyness says whether exercising now would gain (in the money), break even (at the money) or lose (out of the money).

Understand Option Payoffs and Moneyness

An option gives the buyer a right, not an obligation. A call is the right to buy the underlying at the exercise price (strike) X. A put is the right to sell at X. The buyer pays a premium to the seller (writer) up front. The seller takes the premium and must perform if the buyer exercises.

Because the buyer can walk away, the payoff at expiration can never be negative for the buyer. A call is worth exercising only if the underlying price S is above X. A put is worth exercising only if S is below X. That is why the payoffs use max(0, ...).

The seller's payoff is the mirror image of the buyer's. Whatever the buyer gains at expiration, the seller loses, and the reverse. Payoffs sum to zero. Profit then adds the premium: the buyer subtracts it, the seller keeps it.

Moneyness compares S with X right now. A call is in the money (ITM) if S > X, at the money (ATM) if S = X, and out of the money (OTM) if S < X. For a put it is the opposite: ITM if S < X, OTM if S > X.

Before expiration, option price = intrinsic value + time value. Intrinsic value is the payoff if exercised immediately: max(0, S − X) for a call, max(0, X − S) for a put. Time value is the premium minus intrinsic value. It reflects the chance that the option moves further into the money, so it is highest near ATM and falls to zero at expiration.

Key formulas to remember

Call payoff at expiration (buyer)
max(0, S − X)
S is the underlying price at expiration, X the exercise price.
Put payoff at expiration (buyer)
max(0, X − S)
Never negative for the buyer.
Profit, option buyer
Profit = Payoff − Premium
Maximum loss for the buyer is the premium.
Profit, option seller
Profit = Premium − Payoff
Seller's payoff is −max(0, S − X) for a call and −max(0, X − S) for a put.
Breakeven price
Call: S = X + premium; Put: S = X − premium
Same breakeven for buyer and seller.
Maximum profit and loss
Long call: loss = premium, profit unlimited. Long put: loss = premium, profit = X − premium (S falls to zero). Short call: profit = premium, loss unlimited. Short put: profit = premium, loss = X − premium.
Assumes the underlying price cannot fall below zero.
Intrinsic value (before expiration)
Call: max(0, S − X); Put: max(0, X − S)
Uses the current price S.
Time value
Time value = Option premium − Intrinsic value
Zero at expiration.

How to solve Option Payoffs and Moneyness questions

Use this routine for any payoff, profit or moneyness question.

  1. 1Identify the option type (call or put) and the position (long or short).
  2. 2Write down S, X and the premium. Check whether S is the current price or the expiration price.
  3. 3Compute the buyer's payoff with max(0, S − X) for a call or max(0, X − S) for a put.
  4. 4If you are the seller, flip the sign of the payoff.
  5. 5For profit, subtract the premium for the buyer or add it for the seller.
  6. 6For moneyness, compare S with X, remembering that puts are reversed relative to calls.
  7. 7For value before expiration, intrinsic value = the payoff formula with the current S. Time value = premium − intrinsic value.
  8. 8Sanity check: the buyer's loss cannot exceed the premium, and the buyer's gain equals the seller's loss.

Quickest way: Sign and sketch shortcut

When to use it: Use this when you need to eliminate choices quickly in a payoff or profit question.

  1. Ask first: is the option in the money? If not, the payoff is 0 and the buyer's profit is minus the premium.
  2. If it is in the money, the payoff is just the gap between S and X.
  3. Subtract the premium for the buyer. Seller's profit is the exact negative.
  4. Any option showing a buyer loss larger than the premium is wrong. Eliminate it.
  5. For breakeven, move from X by the premium: up for a call, down for a put.

Common mistakes in Option Payoffs and Moneyness

  • Reporting a negative payoff for a long option that expires out of the money.

    You compute S − X without applying the floor at zero.

    Fix: Always write max(0, ...). The buyer's payoff is 0, and the profit is minus the premium.

  • Forgetting the premium when asked for profit.

    Payoff and profit sound similar.

    Fix: Underline the word 'profit' or 'net'. Then subtract the premium for the buyer.

  • Applying call moneyness rules to puts.

    You memorise 'S above X is in the money' for all options.

    Fix: For a put, in the money means S < X. Test by asking whether exercising gains.

  • Calling time value the whole premium for an in-the-money option.

    You ignore intrinsic value.

    Fix: Subtract intrinsic value from the premium first. An American option never trades below intrinsic value; a European option sometimes can (for example, a deep in-the-money European put), giving negative time value.

  • Giving the seller the buyer's sign.

    You calculate the buyer's result and stop.

    Fix: The seller's profit is the negative of the buyer's profit for the same option.

Worked examples

Example 1

An investor buys a European call on a share with exercise price $50 and pays a premium of $3. At expiration the share trades at $58. What is the investor's profit, and what is the seller's profit?

Show the solution
  1. Call payoff = max(0, 58 − 50) = $8.
  2. Buyer's profit = 8 − 3 = $5.
  3. Seller's profit is the negative: 3 − 8 = −$5.
  4. Check: breakeven is 50 + 3 = $53, and $58 is above it, so the buyer profits.

Answer: The buyer earns a profit of $5 per share and the seller loses $5 per share.

Example 2

A put option has exercise price €40 and is trading at a premium of €6 when the share price is €36. What are the put's moneyness, intrinsic value and time value?

Show the solution
  1. For a put, S < X means in the money: 36 < 40, so it is in the money.
  2. Intrinsic value = max(0, 40 − 36) = €4.
  3. Time value = premium − intrinsic value = 6 − 4 = €2.

Answer: The put is in the money, with intrinsic value of €4 and time value of €2.

Exam tips

  • Questions often ask for profit but offer the payoff as a trap option. Read the last line first.
  • Expect a question on who has limited versus unlimited loss. Only the short call has unlimited loss.
  • Moneyness questions on puts are common. Test with 'would I gain by exercising now?'.
  • No penalty for wrong answers: if unsure, eliminate any option where the buyer loses more than the premium, then guess.

Practice questions from Pricing and Valuation of Options

Option Payoffs and Moneyness in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Option Payoffs and Moneyness: frequently asked questions

What is the difference between option payoff and option profit?

Payoff is the value of the option at expiration, ignoring what you paid. Profit subtracts the premium for the buyer or adds it for the seller. A long call can have a positive payoff and still show a loss if the payoff is smaller than the premium.

What is the difference between intrinsic value and time value?

Intrinsic value is what you would receive by exercising now, floored at zero. Time value is the rest of the premium, which pays for the chance of further favourable moves. At expiration, time value is zero.

How do you tell if an option is ITM, ATM or OTM?

Compare the underlying price S with the exercise price X. A call is in the money when S > X and a put is in the money when S < X. At the money means S = X, and out of the money is the opposite of in the money.

Why is the maximum loss of an option buyer limited?

The buyer can choose not to exercise, so the worst outcome is losing the premium paid. The seller has no such choice, so the seller's loss can be large, and unlimited for a short call.