9 Option Strategies CH 11
9 Option Strategies CH 11
9 Option Strategies CH 11
Chapter 11
Trading Strategies
Take a position in
The
option and the underlying asset Two or more options of the same type
Spread
Combinations
Recall that options can provide insurance against price declines (puts) and increases (calls)
Floor:
Long
put option coupled with underlying asset Also called a protective put
The
long position in the put protects the investor from a sharp decline in stock prices
Insurance
on stock prices since downside risk is limited, but can take advantage of upside potential when stock prices increase
Payoff/profit
10
5 0 40 -5 -10 -15 -20 45 50 55 60 65 70
Stock
Put
Payoff
Profit
Covered Calls
Potential losses from the shorted calls are offset by the long positions in the stock
Similar
The
5
0 40 -5 -10 -15 -20 -25 45 50 55 60 65 70
Stock
Call
Payoff
Profit
Other Strategies
Cap
Short
Covered put
Short
stock, short
Protects
put
Price
declines lead to losses on put, but gains on short underlying Price increases incur premium retention, but offset by losses on short underlying
Looks
like a short
call
Spreads
Combinations of two or more options of the same variety (calls or puts) Make small bets on movement of prices
Limited
Bull Spreads
a call with a low strike price, sell a call with a high strike price (same T) or Buy a put with a low strike price, sell a put with a high strike price (same T)
Limits
Also
Bull Spreads
Bull Spreads
Call Bull Spread Payoff Diagram
20 15
10
0 Profit
-5
-10
-15
-20
Stock Price
C1 C2 Spread
5
Payoff
0 15 -5 -10 -15 20 25 30 35 40 45 50
-20
P1 P2 Spread
Bear Spreads
a call with a high strike price and sell a call with a low strike price or Buy a put with a high strike price and sell a put with a low strike price
Both
Bear Spreads
Bear Spreads
Call Bear Spread
15 10 5 0 15 -5 -10 20 25 30 35 40 45 50
Payoff
-15
-20 C1 C2 Spread
15
10 5 0 15 -5 -10 -15 P1 P2 Spread 20 25 30 35 40 45 50
Payoff
Box spreads
Use
combinations of puts and calls to create a synthetic long forward at one strike and a synthetic short forward at a different strike
Costly,
Ratio spreads
Instead
of one-to-one ratio between bought and sold calls (or puts), buy m options at one strike and sell n options at a different strike
Possible
Collars
Holder of a stock buys a put with a low x and sells a call with a high X
Collar
width
between call and put Xs
Difference
Call
Payoff
is similar to a short forward If own the underlying, payoff looks like a bull spread
Collared stock
Normally
Spread
Bull spreads, bear spreads, floors, caps are all directional plays
Anticipate
What happens when we expect large (or small) price movements, but we dont know in which direction the movement will occur?
News
driven events
Lawsuit
Butterfly Spreads
Low cost option strategy Appropriate for investors who feel that large price moves are unlikely Can be made with either puts or calls
Buy (sell) lo & hi calls (or puts) and sell (buy) 2 middle calls (or puts) Expect stock price to move a lot, but dont know which direction
Reverse butterflies
Practice put butterflies and reverse call or put butterflies on your own
Butterfly Spreads
Butterfly Spreads
Call Butterfly Spread
30
20
10
0 Profit
-10
-20
-30
-40
-50 Stock
C1 C2 C3 Spread
With any of the above strategies, the investor expects extremely large price movements (high volatility), but doesnt know in which direction the price will move
Shorts
Straddle: buy a call and a put with the same strike, same T Straps: buy one put and more than one call with same X, T
Strips: buy one call and more than one put with same X, T
Strangle: buy one put with low strike, one call with high strike, same T
Straddle Payoffs
Straddle Payoffs
Straddle
30
25
20
15
Profit
10
-5
-10
Stock
C1 P1
Calendar Spreads
Time or horizontal spread involves the purchase of one option at a strike = X1 and T = T1 and the sale of another with a strike = X1 and T = T2, where T1 T2
Cannot
Longest
holding period possible is T1 Cost is proportional to maturity, and usually requires an initial investment More complicated than other spreads
Calendar Spreads
Since both have the same X, both have the same intrinsic value
Profitability
is determined solely by the difference in time values This does not mean that you should always purchase the long-term option and short the short-term option
Depends
Neutral: strike price close to current S is chosen Bullish: X > S Bearish: X < S
Calendar Spreads
Much like butterfly and combinations, volatility is a major factor in the performance of a calendar spread
Profits
are highest if low volatility If prices move too far away from the exercise price, the time value becomes low for both options and profits are eroded
If