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In: English and Literature

Submitted By snowmancd
Words 851
Pages 4
Trading Strategies Involving Options

BUSINESS
SCHOOL

1

Overview
› How options can be used for hedging a pre-existing position in the spot market, and for speculating on subsequent spot movements. › Hedging
- Fiduciary call writing
- Covered call writing
- Protective put buying

› Synthetic futures contracts
› Speculating
- Spreads
- Straddles
- other

2

› Fiduciary call writing
- Writing call options against an asset already held
- Involves frequent rebalancing to maintain a hedged position

› Covered call writing
- Hedger simply writes one call option for each unit of asset held

› Synthetic puts
- Created by one call option for each unit of an asset sold short

› Protective put buying
- Purchase of put options to insure a long asset position

› Synthetic call
- The combination of a short asset and a written put
3

Creating Synthetic Futures Contracts

› Options can be combined to create synthetic futures contracts › A combination of options that consists of a written
European call and a purchased european put, with the same exercise prices and expirations, behaves in a manner identical to a short position in a futures contract. › A long position in a synthetic futures contract is created by purchasing European calls and writing corresponding puts.
4

Put-call futures parity
› A riskless portfolio consisting of short futures contract and long synthetic futures contract
Position

Current Value

STX

Short Futures

0

Tf0

Long Call

CE

0

ST-X

Short Put

-PE

-(X-ST)

0

Tf0

Tf0

CE -PE

- ST

–X

Tf0

- ST

–X

› The portfolio’s current worth must be the PV of the expiration worth. In equilibrium we therefore have:
CE -PE

= (Tf0 – X)e-rT
5

› A riskless portfolio consisting of long futures contract and short synthetic futures contract
Position

Current Value

STX

Long Futures

0

ST - Tf0

ST - Tf0

Short Call

-CE

0

-(ST-X)

Long Put

PE

X - ST

0

PE -CE

X – Tf0

X – Tf0

› The portfolio’s current worth must be the PV of the expiration worth. In equilibrium we therefore have:
PE -CE

= (X – Tf0)e-rT
6

Three Alternative Strategies

› Take a position in the option and the underlying
› Take a position in 2 or more options of the same type (A spread) › Combination: Take a position in a mixture of calls & puts
(A combination)

7

Positions in an Option & the
Underlying
Profit

Profit

K
K

ST

ST

(a)
Profit

Profit

(b)

K
ST
(c)

K

ST

(d)
8

Bull Spread Using Calls

Profit
ST

K1

K2

9

Bull Spread Using Puts

Profit
K1

K2

ST

10

Bull Money Spread
S=$50
Buy

C=$4, X=$47

Write

C=$1, X=$52
2

Max loss = $3 (when X$52)
BE of X of long option – net premium

-3

= 47 – (1-4) = $50
46

48

50

52

54

56

11

Bear Spread Using Puts
Figure 10.4, page 233

Profit

K1

K2

ST

12

Bear Spread Using Calls
Figure 10.5, page 234

Profit
K1

K2

ST

13

Bear money spread

S=$50
Write

P=$1, X=$47

Buy P=$4, X=$52
Max loss = $3 (when X$52)
BE of X of long option – net premium
= 52 – (4-1) = $49
14

Advanced Speculative Strategies: Other
Strategies

› Straddle
- A straddle consists of two options, one a call and the other a corresponding put. It is used to speculate on a forecast of excessive spot price variability. A reverse straddle is created by writing the call and corresponding put. › Straps
- A combination of two long calls and one long corresponding put

› Strips
- A combination of two long puts and one long corresponding call

15

Box Spread
› A combination of a bull call spread and a bear put spread
› If all options are European a box spread is worth the present value of the difference between the strike prices
› If they are American this is not necessarily so (see Business Snapshot
10.1)

16

Butterfly Spread Using Calls

Profit
K1

K2

K3

ST

17

Butterfly Spread Using Puts
Figure 10.7, page 238

Profit
K1

K2

K3

ST

18

› Butterfly spread
- Combination of a bull money spread and a bear money spread
- Used on a forecast of spot-price stability

› Calendar spread
- Created by writing a shorter maturity option and purchasing an otherwise equivalent but longer term option. A reverse calendar spread is engineered in the opposite manner

19

Butterfly spread
Option position

Option price

Investment

Long One call, X=$25

$1

+$1

Short two calls, X=$20

$3

-$6

Long one call, X=$15

$6

+$6
+$1

20

Calendar Spread Using Calls

Profit
ST

K

21

Calendar Spread Using Puts

Profit
ST

K

22

A Straddle Combination

Profit

K

ST

23

Straddle

S=$60
C=$3, X=$58
P=$2, X=$58
BE = X + or – investment

= $53 and $63

45

50

55

60

65

70

-5

24

Strip & Strap
Profit

Profit

K
Strip

ST

K

ST

Strap
25

Strap

S=$60
C=$3, X=$58
P=$2, X=$58
5

45

50

55

60

65

70

-8

26

Strip

S=$60
C=$3, X=$58
P=$2, X=$58

45

50

55

60

65

70

-7

27

A Strangle Combination

Profit
K1

K2

ST

28

END
QUESTIONS
SECTION DIVIDER [1 line only]

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