OVERVIEW, TRADING STRATEGIES
1. Trading strategies involving a single option on a stock and the stock itself:
i) Covered call; ii) Protective put
2. Trading strategies involving taking a position in two or more options of the same type:
i) Bull spreads; ii) Bear spreads; iii) Butter‡y spreads
3. Combinations: Option trading strategies that involve taking a position in both calls and puts on the same stock:
i) Straddles; ii) Strips; iii) Straps; iv) Strangles

COVERED CALL
Consider a portfolio that consists of a long position (buy) in a stock plus a short position (sell) in a call option
The investment strategy represented by this portfolio is known as writing a covered call
This is because the long stock position "covers" or protects the investor from the possibility of a sharp rise in the stock price. lp on St and a sp on C z Pro…t ( ): ST
S T < X : ST

payo¤
}|
max(ST

St + C

{z

X; 0)

cost
}| {
St + C

When ST < X the pro…t is a positive function of ST
(slope +1)
When ST = 0:
= St + C (maximum loss). From upper bound of a call this is negative: C St

S T > X : ST

(ST

X)

St + C = X

St + C

When ST > X the pro…t is not a¤ected by changes in
ST (slope 0)
When ST = X :
= X
St + C (maximum gain).
From lower bound of a call this is positive:
C St
C+X

Xe r(T t) =) C + Xe r(T t)
St 0

Finally, the pro…t is zero when
S T = St C

= ST

St

0)

St + C = 0 )

An investor will invest in this strategy if he/she believes that ST
St C
See graph covered call

Covered call: Lp on St and a sp on C
But from the put call parity we have:
C +Xe r(T t) = P +St =) St C = Xe r(T t) P

That is why the pro…t of this strategy is similar to the one of selling a put
The reverse of writing a covered call is a short position
(sell) in a stock combined with a long position (buy) in a call option

Pro…t ( ):
ST < X :
ST > X :

z

payo¤
}|
max(ST
St + C )

{z

cost
}|
{
(St C )

[S T
X;