Let's think about the pay off diagram for just owning the stock or we can say "going long the stock", which

is really just owning it. If we think about just

the underlying asset value and we're talking about

the value at some date and, you know, and traditionally

we're talking about some maturity date for some options,

but the value at maturity but at some date we have in our mind. So if we're thinking about just the value, if on that date the

underlying stock price is 50, then the value of holding

the stock is going to be 50. If the value of the underlying stock is 0, then the value of owning

stock is going to be 0.

If the value of the

underlying stock is 70, then the value of the

stock is going to be 70. So you just have this very

simple line payoff diagram. It's just whatever the

underlying stock price, that is the value of the asset

because you just own the stock. If you think about it from a

profit and loss point of view, you break even if on that

day since you're paying $50 per share for it today, if on whatever day we're talking about, the stock price at some future date, at maturity for some …

for some type of option. You paid 50. If the value is

50, then you're at break even.

If the value is at 0,

then you just lost $50. So you're going to be at -50 over here. If the value of the stock

price on that day goes to 60, 70, 80, 90, 100,

then you just made $50. So it's going to be this

point right up here. Your profit will be 50. So

you see, a payoff diagram that looks something like this. And once again, the only

difference between this payoff diagram and that payoff diagram

is that this one right here is shifted down by $50

to incorporate the price that you paid for it. Now,

let's say this is what happens if you just buy the stock

and let's say you want to buy the stock and let's say,

you want to buy the stock, but you want to mitigate

your downside risk. You want to buy some

insurance on your stock. You want to mitigate the downside. So what you can do is, you

can literally just also buy a put option, maybe with a

strike price right at $50. You want to mitigate your

downside if the stock goes below 50 and if you do that

and I'll only do it on this payoff diagram, you could just

shift it down for this one.

What would it look like? Well, just the put options

payoff diagram looks like this. We've already drawn. Let me

try to do that in the color of the put option. We've

already done that in a previous video. It looks something like this. If the underlying stock price

is 0, then the put option is worth 50 because you can buy

it for 0 … Buy the stock for 0 and then you have

the right to sell it for 50 and then the value of the put

option is worthless if the stock can actually be sold for 50, then you wouldn't exercise the put option.

But what happens if you own both? If you own both at maybe

the maturity of the option, if the stock is worth 0,

your stock part is worth 0 but the option is worth

50, so the combination is going to be worth 50. If the stock is worth 25 …

If the stock is worth 25, then the put option is also worth 25. So if you own both of them,

the combination is going to be worth 50. If the stock

is worth 50, the put option is worth 0. You own the combination

is going to be worth 50. Anything above 50, the put

option is just worth 0 but then you have the value of the stock. So the stock + the put would

look like this payoff diagram, would just look like this

payoff diagram right over here. So when you look at this,

what happened is we'll get all of the upside if the stock goes above 50, but we've mitigated our downside.

This is … This right here

is the stock + the put option. And what you see here is the

put is acting as insurance. When people talk about buying

insurance on a position, they're usually talking

about buying a put option. And of course if we were to

draw the same graph over here we would shift it down

by the amount you pay for the stock and for the

$10 that you're paying for the put option. So, you

would shift this graph down by $60 because that's what it

pays …

what it costs to go into this position..