1
Trading Strategies
Involving Options
Chapter 10
2
Positions in an Option & the
Underlying
• Buy or sell call
• Buy or sell put
• buy or short sell stock
• buy (lend at) or sell (borrow at) risk-free
bond (rate)
3
Trading Strategies Involving
Options
• Take a position in the option & the
•
•
underlying
Spread: Position in 2 or more
options of the same type
Combination: Position in a mixture
of calls & puts
4
Payoff for Put Option
x
Cost = p
buy
X
sell
-X
Cost = -p
ST
5
Payoff for Call Option
x
Cost = c
buy
X
sell
ST
Cost = -c
6
Payoff for Stock
buy
Cost = S
ST
sell
Cost = -S
Payoff for Investing or
Borrowing PV(X) in
Risk-Free Bond
Cost = Xe-rT
X
buy
ST
Cost = -Xe-rT
-X
sell
7
8
Method
• Draw payoff pattern for each position
• Add patterns together to obtain payout
•
•
pattern
Determine cost of portfolio
Subtract cost of portfolio to obtain profit
pattern
9
Write a Covered Call
buy stock
Cost = S - c
X
X
sell
call
ST
10
Profit Pattern for Covered Call
Cost = S - c
X
X-S+c
X
-S+c
X-S+c
ST
11
Payoff for Protective Put
Cost = S + p
x
X
ST
12
Profit Pattern Protective Put
Cost = S + p
x
X
ST
X-S-p
S+p
13
Bull Spread
• Buy 1 call and sell 1 call at higher strike
X2-X1
buy
X1
Cost = c1 - c2 > 0
X2
ST
sell
14
Profit Pattern for Bull Spread
X2-X1 -c1+c2
-c1+c2
ST
15
Bear Spread
• Sell 1 call and buy 1 call at higher strike
buy
Cost = c1 - c2 < 0
X1
sell
X2-X1
X2
ST
16
Profit Pattern for Bear Spread
Cost = c1 - c2 < 0
X1
X2
ST
17
Buy a Straddle
• Buy 1 call and 1 put at same strike
X
Cost = c + p
payout
profit
X
-p-c
X-p-c
X+p+c
18
Butterfly Spread
• Buy 1 call at X1, sell 2 calls at X2, buy 1 call
at X3
m = +1
m = -1
m=0
X2
X1
X3
m=-2
Cost = c1 - 2c2 + c3
19
Butterfly Spread
• Buy 1 call, sell 2 calls, buy 1 call
X2-X1
payoff
cost
profit
Cost = c1 - 2c2 + c3
20
Bull Spread Using Calls
•
Figure 10.2
Profit
X1
X2
ST
21
Bull Spread Using Puts
•
Figure 10.3
Profit
X1
X2
ST
22
Bear Spread Using Calls
•
Figure 10.4
Profit
X1
X2
ST
23
Bear Spread Using Puts
•
Figure 10.5
Profit
X1
X2
ST
24
Butterfly Spread Using Calls
•
Figure 10.6
Profit
X1
X2
X3
ST
25
Butterfly Spread Using Puts
•
Figure 10.7
Profit
X1
X2
X3
ST
26
A Straddle Combination
•
Figure 10.10
Profit
X
ST
27
Strip & Strap
•
Figure 10.11
Profit
Profit
X
Strip
ST
X
Strap
ST
28
A Strangle Combination
•
Figure 10.12
Profit
X1
X2
ST
29
Summary
• Write covered call: buy stock sell call
• Protective put: buy stock and buy put
• Bull spread: buy X1 call and sell X2 call
• Bear spread: opposite of bull
• Buy Straddle: buy X call and buy X put
• Sell Straddle: opposite of buy straddle
• Strangle: buy X1 put and buy X2 call
• Butterfly spread: buy 1 X1 call, sell 2 X2 calls,
and buy 1 X3 call