Definition
Maximum Loss / Maximum Profit
Maximum loss and maximum profit are the worst- and best-case outcomes of an option strategy at expiry, defining its risk-reward.
Every defined-risk strategy has a calculable maximum loss and maximum profit. For a debit spread, the max loss is the net premium paid and the max profit is the strike width minus that premium; for a credit spread it is the reverse. Naked options, by contrast, have unlimited or very large maximum loss.
Indian traders compute these before placing any trade on Nifty, Bank Nifty, or stocks to know their exact exposure and to size positions sensibly. Knowing the maximum loss is essential for risk management, and comparing it with the maximum profit gives the trade's risk-reward ratio.
Related terms
- Iron CondorAn iron condor sells an out-of-the-money call spread and put spread to earn premium in a range-bound market with defined risk.
- Naked Option SellingNaked option selling is writing a call or put without a hedge or the underlying, exposing the seller to large or unlimited risk.
- Break-even Point (Options)The break-even point is the underlying price at which an option strategy neither makes nor loses money at expiry.
- Vertical SpreadA vertical spread buys and sells two options of the same type and expiry but different strikes, capping both risk and reward.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.