Basic Points

• The breakeven price of a trade is where (and when) you can close out a trade without losing any money including all trading costs (commissions and borrowing costs). 
• Since investment products have a spread (sold at higher prices and bought at lower prices due to the nature of the auction process), this spread must be beaten as well to break even. Options have a wider spread than most stocks, which makes this more of a challenge.
• On an option’s risk chart, the curved rather than the jagged line shows the breakeven price at any given point. However, on the best risk charts these curves can be affected by implied volatility (IV), which is why options cost extra depending on market demand for them and investor expectations that the trading range will increase. 

Intermediate: Examples and Nuances

With options, the breakeven price is easiest to calculate if the option is left to expire: The premium amount is how many points (dollars) the underlying security must move by expiration for breakeven. Everything beyond that amount is profit. For example, if a long call or a long call vertical (long a call and short a call further OTM) has a debit amount of $3.20, then the underlying must move $3.20 above the strike price by expiration for it to close at a profit (also factoring in slippage). What we call slippage is the net effect of how buying and immediately selling the same investment products causes losses due to commissions and different prices where they are bought versus sold. 

Extending this example to trade with a credit, which applies to short options and short option spreads (such as selling a call and buying another call further OTM), if the premium collected on a short call is say $4.72 to open, then the price can fall $4.72 below the strike price by expiration without a loss. This is part of the attraction to premium selling: The trader can be mildly wrong about direction and still profit. In fact, the trader can still hit max profit while being mildly wrong about direction, provided that their short option expires worthless.

Roughly, the delta amount at the moment of the trade is the probability that it will close at least that far in strike by expiration. This means that if a long call is opened at 22 delta, then there is about a 22% chance that it will expire above breakeven. 

If the trader closes before expiration, positive PnL requires that the underlying for the long option has moved more than the options market has priced in by that point, which is going to be less than the debit, and an even smaller amount if only a little bit of time has passed. On the other hand, if opening a credit and closing before expiration, then a profitable close depends on the underlying moving less than the options market is pricing in by that point. On an options risk graph, the near-term breakeven points (as well as the instantaneous PnL) are shown as the more curved line, while the more jagged line shows the [pure intrinsic value] outcome at expiration.

Advanced: Greek Dynamics

As a real-time dynamic, if IV increases, then this has the same effect on the pricing of the option as if it suddenly had more time left. This is because IV not only prices in the extent of the implied range but functions like synthetic time. The time value remaining in an option’s (extrinsic value) is proportional to the square root of time. Therefore, if long an option, whether a put or call, then its value always increases if IV increases, which helps long option holders to close early for a tidy profit. However, if the underlying moves enough against the option, then this can mean net losses despite gains from IV. On the flip side, credits (short options or spreads) suffer a penalty when IV increases. 

IV crush (the sudden decrease of implied volatility and therefore an option’s price) is often a problem for long calls, which tend to lose some value from IV crush despite gains in the underlying. Puts, on the other hand, tend to be right about direction and IV at the same time. But then again, puts tend to be more expensive!

What is also critical to understand is that IV is no longer part of the equation if the option expires. IV pertains to extrinsic value, which slowly becomes drained out of the option’s price as time runs out on the contract. At expiration, only intrinsic value is left, which is exclusively connected with the price of the underlying. When examining a risk diagram for an option, it will have sharper and more jagged lines near expiration, but softer lines if it has more time left since that is the effect of extrinsic value added on top as part of the option’s price.