But how do we quantify risk?

For the moment, let’s only confine our discussion to stocks and investments, as this article is a tutorial about financial investment and trading activities.

In a simplest way, let’s assume that there is a stock that is available for free – means, the price of that stock is zero. Also assume that there are no brokers involved in the transaction and we don’t have to pay any security transaction taxes. To make the discussion easy, let’s name the stock – let’s call it GOOGOL.

So, you buy this googol stock for zero dollars today (date 7th September). Hence, you will have this position:

Since you bought this stock for zero on 7^th September, and the price stayed at zero for the whole day, your profit/loss will be zero.

Suppose, tomorrow on 8^th September, the price rises to 1 dollar. So we will have the following situation:

With respect to the buying price of zero, your profit/loss on 8^th September will be 1, because the stock price has gone upto 1.

Suppose, the next day on 9^th September, the price rises to 2 dollars. Then we will have the following situation.

Suppose, even negative prices are possible. So, if the next day, on 10^th September, the price falls from 2 dollars to -1 dollars, then we will have:

Therefore, our profit and loss will move as per our Stock price movement, as listed in the above table.

Now, let’s draw a graph for the Stock Price and Profit/Loss. We will have the following:

As you can observe, that we have plotted the Stock price values on the horizontal axis (x-axis), and the profit/loss values on the vertical axis (y-axis) – and we arrive at the above graph. The negative values on vertical axis indicate loss, while positive values indicate profits.

Let's head over to the next part Options Payoff Functions Continued