Trading Strategies Involving Options

Chapter 11

11.1

Three Alternative Strategies

 Take a position in the option and the underlying asset  Take a position in 2 or more options of the same type, i.e. all calls or all puts (spread)  Combination: Take a position in a mixture of calls & puts (combination)

11.2

Positions in an option & the underlying stock (put-call parity)

Profit

K

( a ) Short put Profit

K S

(c) Long call

S T T

Profit

K

(b) Long put Profit

K

(d) Short call

S T S T

11.3

Bull Spread Using Calls (buy low K, sell high K)

Profit

K 1 K 2 S T

11.4

Bull Spread Using Puts (buy low K, sell high K)

Profit

K 1 K 2 S T

11.5

Bear Spread Using Puts (buy high K, sell low K)

Profit

K 1 K 2 S T

11.6

Bear Spread Using Calls (buy high, sell low K)

Profit

K 1 K 2 S T

11.7

Box Spread

 A combination of a bull call spread and a bear put spread  Payoff diagram looks like a box  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

11.8

Butterfly Spread Using Calls (buy lowest and highest K, sell 2 intermediate K)

Profit

K 1 K 2 K 3 S T

11.9

Butterfly Spread Using Puts (buy highest and lowest K, sell 2 intermediate K)

Profit

K 1 K 2 K 3 S T

11.10

Calendar Spread Using Calls (short short, long long; at short maturity date) Result looks like a butterfly spread

Profit

S T K

11.11

Calendar Spread Using Puts (short short, long long; at short maturity date) Result looks like a butterfly spread

Profit

S T K

11.12

A Straddle Combination: long call and put (same K, same expiry)

Profit

K S T

11.13

Strip (2 puts, 1 call) & Strap (2 calls, 1 put)

Profit Profit

K S T

Strip

K S T

Strap

11.14

A Strangle: similar to straddle but call K > put K

Profit

K 1 K 2 S T

11.15

Strangle not!: what if call K < put K?

Profit

K 1 K 2 S T

11.16