Option Payoff (include option premium or exclude??)

CFA Level III
#1

R25 Fixed Income Portfolio Mgt II

Credit Spread Option-

Payoff calculation= Max[(Spread at the option maturity-K) X Notional Amt X Risk Factor,0]

------ I don’t understand why the premium paid is not as a part of the consideration??

2009 Mock exam has questions provide the premium but didn’t incl in the payoff calculation… (But unfortunately I include…>

R37 Risk mgt Application of Option Strategies

eg, Bull call strategies.

Payoff= Max (0x ST-XL)-Max…-CL0+CH0

------ here counts all the premiums…

Maybe I am in the final stage… feeling stress& confused…

Pls someone can help?

#2

I think its teminology. Payoff Vs Profit. Credit options are generally used purely for insurance purposes and payoffs are huge in case of credit event, so insurance premium is irrelavant. Options strategies are more market movement bets/hedges that depend on penny calculations, so premiums matter.

Move on.

#3

Payoff does not include cost of option. Profit does.