Accounting for Profit & Loss in

Call Option
Let’s take the Exercise price at $ 100, the call option premium at $
10, and a Maximum of 200 equity shares. Now we will find out
payoff and profit/loss of the buyer and seller of the option if the
settlement price is $ 90, $ 105, $ 110, and $ 120

“Call” option on equity shares-Profit /loss calculation for both

option seller and buyer

Exercise price = $ 100 Scenario-1 Scenario-2 Scenario-3 Sce

Settlement price (under different

90 105 110
scenarios)

Call option premium(option

2000 2000 2000
premium*lot size) ($ 10*200)

0
Payment to be made by call option 1000 2000
(since settlement price is
buyer= (settlement price-exercise =200*(105- =200*(110- =20
less he will not exercise
price)x lot size 100) 100)
option)

Profit or loss to a buyer( payment -1000 0

-2000
made minus premium paid) (1000-20000 (2000-2000) (400

The payoff for call seller=

Max(settlement price-exercise price)x 0 -1000 -2000
lot size

Payoff of call seller = Pay off minus

2000 1000 0 -
premium paid
I hope now you understand how the profit/loss is calculated in the
case of derivatives.

Let us take one more example with dates, and I will explain
the accounting entries in derivatives that will flow based on the
scenario.

Accounting for Profit & Loss in

Put Options
“Put” option on equity shares-Profit /loss calculation for both
option seller and buyer

Scenario- Scenario- Scenario- S

Exercise price = $ 100
1 2 3

Settlement price (under different scenarios) 80 90 100

Call option premium ($ 7*200) 1400 1400 1400

Payment to be made by put option buyer= (Exercise price-

4000 2000 0
settlement price)x lot size

Profit or loss to put buyer( payment made minus premium

2600 600 -1400
paid)

The payoff for put writer = Max(Exercise price-settlement

-4000 -2000 0
price)x lot size

Payoff of call writer= Payoff minus premium paid -2600 -600 1400

Let us take on examples to understand how to calculate accounting

entries on derivative transactions in the books of “Writer and Buyer
of Call and Put options (the Next four examples are based on
this- Writer call, Buyer call, Writer put, Buyer Put)
Accounting for Derivatives –
Writing a call
Mr. A has written a call option (i.e., Sold Call option); details are
as follows with a lot size of 1000 X Limited shares on 1 st Feb 2016
with a premium of $ 5 per share. The exercise date is 31st Dec 2016,
and the Exercise price is $ 102 per share.

The market price on 1st Feb 2016 =100 per share :

The market price on 31st Mar 2016 =104 per share :

The market price on 31st Dec 2016 =105 per share

Solution:

In this contract, “A” Agrees to Buy shares at $ 102 despite whatever

the price is on 31st Dec 2016.

So fair value of an option, in this case, is as follows

On 1st Feb 2016(The date on which the contract was entered) Fair
value of option= $ 5000

On 31st March 2016(Reporting date) = 5000-(104-102)*100= $ 3000

On 31st Dec 2016(Expiry date) = 5000-(105-102)*100=$ 2000

Accounting entries:

Date Particulars Dr

1st Feb 2016 Bank account Dr 5000

Call option obligation account Cr

 Date Particulars Dr

(Option premium received for writing call options)(Call premium of $

5000)

31st Mar 2016

(Reporting Call option obligation account Dr 2000
date)

Fair value gain account Cr

(Increase in fair value of the option)($ 5000- $ 3000)

31st Dec 2016

Call option obligation account Dr 1000
(Exercise date)

Fair value gain account Cr

(Increase in fair value of option)($ 3000- $ 2000)

31st Dec 2016

Call option obligation account Dr 2000
(Exercise date)

Bank account Cr

(Cash settlement on the exercise of the call option)($ 5000-$ 2000-$ 1000)

Incase transaction is settled in shares

 Date Particulars Dr

31st Dec 2016

Call option obligation account Dr 2000
(Exercise date)

Shares of X Limited Cr

(Cash settlement on the exercise of the call option)($ 5000-$ 2000-$ 1000)

Cash for shares: i.e gross shares settlement

1st Feb 2016 Bank account Dr 5000

Call option obligation account Cr

(Option premium received for writing call options)(Call premium of $

5000)

31st Mar 2016

(Reporting No entry required –
date)

This is an equity settlement, Change in fair value of the option is not

recognized

31st Dec 2016

Bank Account Dr 102000
(Exercise date)

Shares of X Limited Account Cr

(Settling the transaction in shares)($ 102*1000)

Accounting for Derivatives –
Buying a Call
Mr. A purchased a call option (i.e., Bought call option); details
are as follows with a lot size of 1000 X Limited shares on 1 st Feb
2016 with a premium of $ 5 per share. The exercise date is 31st Dec
2016, and the Exercise price is $ 102 per share.

The market price on 1st Feb 2016 =100 per share :

The market price on 31st Mar 2016 =104 per share :

The market price on 31st Dec 2016 =105 per share

Solution: In this contract, “A” purchased a call option to buy shares

of X Ltd at $ 102 per share despite whatever the price was on
31st Dec 2016. If the price of X ltd is more than 102, A will buy shares
at $ 102; otherwise, if the shares are operating below $ 102, he can
deny buying shares at $ 102.

So fair value of the option, in this case, is as follows

On 1st Feb 2016(The date on which the contract was entered) Fair
value of option= $ 5000

On 31st March 2016(Reporting date) = 5000-(104-102)*100= $ 3000

On 31st Dec 2016(Expiry date) = 5000-(105-102)*100=$ 2000

Accounting entries:

Date Particulars Dr

1st Feb 2016 Call option Asset account Dr 5000

 Date Particulars Dr

Bank account Cr

(Option premium paid for buying call options)(Call premium of $ 5000)

31st Mar 2016

(Reporting Fair value loss Account Dr 2000
date)

Call option Asset Account Cr

(Decrease in fair value of the option)($ 5000- $ 3000)

31st Dec 2016

Fair value loss Account Dr 1000
(Exercise date)

Call option Asset Account Cr

(Decrease in fair value of option)($ 5000- $ 3000)

31st Dec 2016

Bank Account Dr 2000
(Exercise date)

Call option Asset Account Cr

(Cash settlement on the exercise of the call option)($ 5000-$ 2000-$ 1000)

Incase transaction is settled in shares of X Limited

31st Dec 2016

Shares of X Limited Dr 2000
(Exercise date)
 Date Particulars Dr

Call option Asset Account Cr

(Shares settlement on the exercise of the call option)($ 5000-$ 2000-$ 1000)

Cash for shares: i.e gross shares settlement

1st Feb 2016 Call option Asset account Dr 5000

Bank account Cr

(Option premium paid for buying call options)(Call premium of $ 5000)

31st Mar 2016

(Reporting No entry required –
date)

This is an equity settlement, Change in fair value of an option is not

recognized

31st Dec 2016

Bank Account Dr 102000
(Exercise date)

Shares of X Limited Account Cr

(Settling the transaction in shares)($ 102*1000)

Accounting for Derivatives –

Writing a Put
Mr. A has written a Put option (i.e., sold Put option); details are as
follows with a lot size of 1000 X Limited shares on 1 st Feb 2016 with
a premium of $ 5 per share. The exercise date is 31st Dec 2016, and
the Exercise price is $ 98 per share

The market price on 1st Feb 2016 =100 per share:

The market price on 31st Mar 2016 =97 per share:

The market price on 31st Dec 2016 =95 per share

Solution: In this contract, “A” sold a put option to buy shares of X

Ltd at $ 98 per share despite whatever the price was on 31st Dec
2016. If the price of X ltd is more than 98, the buyer of an option
may not sell shares to A; otherwise, if the price of X ltd on 31 st Dec
2016 is less than $ 98, then “A” has to buy shares at $ 98.
So fair value of an option, in this case, is as follows

On 1st Feb 2016(The date on which the contract was entered) Fair
value of the option= was $ 5000($ 5*1000 shares)

On 31st March 2016(Reporting date) = 5000-(98-97)*100= $ 4000

On 31st Dec 2016(Expiry date) = 5000-(98-95)*100=$ 2000

Date Particulars Dr

1st Feb 2016 Bank account Dr 5000

Put option obligation account Cr

(Option premium received for writing put options)(put a premium of $

5000)

31st Mar 2016

(Reporting Put option obligation account Dr 1000
date)
Date Particulars Dr

Fair value gain account Cr

(Increase in fair value of put option)($ 5000- $ 4000)

31st Dec 2016

Put option obligation account Dr 2000
(Exercise date)

Fair value gain account Cr

(Increase in fair value of the option)($ 4000- $ 2000)

31st Dec 2016

Put option obligation account Dr 2000
(Exercise date)

Bank account Cr

(Cash settlement on the exercise of the Put option)($ 5000-$ 1000-$ 2000)

Incase transaction is settled in shares

31st Dec 2016

Put option obligation account Dr 2000
(Exercise date)

Shares of X Limited Cr

(Cash settlement on the exercise of the Put option)($ 5000-$ 2000-$ 1000)

Cash for shares: i.e gross shares settlement

1st Feb 2016 Bank account Dr 5000

Call option obligation account Cr

(Option premium received for writing put options)(put a premium of $ 5000)

31st Mar 2016

(Reporting No entry required –
date)

This is an equity settlement, Change in fair value of an option is not

recognized

31st Dec 2016 Bank Account Dr 98000

 Date Particulars Dr

(Exercise date)

Shares of X Limited Account Cr

(Settling the transaction in shares)($ 98*1000)

Accounting for Derivatives

– Buying a Put
Mr. A Bought a Put option details are as follows with a lot size of
1000 shares of X Limited shares on 1st Feb 2016 with a premium of $
5 per share. The exercise date is 31st Dec 2016, and the Exercise
price is $ 98 per share

The market price on 1st Feb 2016 =100 per share:

The market price on 31st Mar 2016 =97 per share:

The market price on 31st Dec 2016 =95 per share

Solution: In this contract, “A” Bought a put option to buy shares of

X Ltd at $ 98 per share despite whatever the price was on 31 st Dec
2016. If the price of X ltd is more than 98 on 31 st Dec 2016, then he
will buy the shares of X ltd at $ 98; otherwise, if the price of X ltd on
31st Dec 2016 is less than $ 98, then “A” can deny purchase at $ 98
and buy-in outside market.

So fair value of an option, in this case, is as follows

On 1st Feb 2016(The date on which the contract was entered) Fair
value of the option= was $ 5000($ 5*1000 shares)

On 31st March 2016(Reporting date) = 5000-(98-97)*100= $ 4000

Date Particulars Dr Cr

1st Feb 2016 Put option Asset Account Dr 5000

Bank Account Cr 5000

(Option premium paid for buying put options)(put a premium of $ 5000)

31st Mar
2016
Fair value loss Account Dr 1000
(Reporting
date)

Put option Asset Account Cr 1000

(Decrease in fair value of put option)($ 5000- $ 4000)

31st Dec
2016
Fair value loss Account Dr 2000
(Exercise
date)

Put option Asset Account Cr 2000

(Decrease in fair value of put option)($ 4000- $ 2000)

31st Dec
2016
Bank Account Dr 2000
(Exercise
date)

Put option Asset Account Cr 2000

(Cash settlement on the exercise of the Put option)($ 5000-$ 1000-$ 2000)( In
this case, Mr. A may deny purchase at $ 98 and Buy in the market at $ 95) For
entry purpose, I am assuming he bought at $ 98 from writer

Incase transaction is settled in shares

31st Dec
2016
Shares of X Limited Dr 2000
(Exercise
date)
On 31st Dec 2016(Expiry date) = 5000-(98-95)*100=$ 2000

I hope you understand how to calculate profit or loss on call and

put options under different scenarios and accounting treatments.
Now let us go into forwards/futures of the company’s equity.