This is a tool that I created in Excel which I used while teaching about hedging opportunities. It is an interactive spreadsheet in which you can input the price of call and put options and choose which options you will buy or sell. The result is a graph showing how the strategy will perform at different prices.
I will give an example of how it works using the options strategy known as ‘The Iron Condor’ (see: http://www.investopedia.com/articles/optioninvestor/06/ironcondor.asp). This first image is of the inputs that we can enter. We will enter the prices of each call and put option before choosing what we would like to buy and/or sell.
First, we will choose to Buy a Put option at $20. The red line on the graph shows our potential outcomes of just this trade. If the price goes below $15 we will make money and we will lose money if it stays above $15.
Next, we will Sell a Put option at $30. Each of our two individual trades are represented on the graph in blue and purple, with the combined trades represented with the thick red line. Now if the price is below $25 we will lose money and above $25 we will make money. Notice that both our losses and gains are capped around -$5 and +$5 respectively.
Next, we will Sell a Call option at $40. Notice that all individual trades are again represented on the graph and the thick red line still combines the value of all the trades. Also notice that as the price keeps going up our losses are potentially uncapped.
Finally, we will Buy a Call option at $50. This gives us the Iron Condor strategy that we were after. If the price stays around the same we will make money, but if it moves up or down we could suffer a loss. However our downside potential is capped.