Trading Strategies Involving Options Chapter 10

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Trading StrategiesInvolving OptionsChapter 10
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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)

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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

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Payoff for Put Option

x
Cost p
buy
ST
X
sell
-X
Cost -p
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Payoff for Call Option

x
Cost c
buy
ST
X
sell
Cost -c
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Payoff for Stock

buy
Cost S
ST
sell
Cost -S
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Payoff for Investing or Borrowing PV(X) in
Risk-Free Bond

Cost Xe-rT
X
buy
ST
Cost -Xe-rT
sell
-X
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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

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Write a Covered Call

buy stock
X
Cost S - c
ST
X
sell call
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Profit Pattern for Covered Call
Cost S - c
X
X-Sc
ST
X
-Sc
X-Sc
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Payoff for Protective Put

Cost S p
x
ST
X
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Profit Pattern Protective Put

Cost S p
x
X
ST
X-S-p
Sp
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Bull Spread

• Buy 1 call and sell 1 call at higher strike

X2-X1
buy
Cost c1 - c2 gt 0
ST
X1
X2
sell
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Profit Pattern for Bull Spread

X2-X1 -c1c2
ST
-c1c2
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Bear Spread

• Sell 1 call and buy 1 call at higher strike

buy
Cost c1 - c2 lt 0
ST
X2
X1
sell
X2-X1
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Profit Pattern for Bear Spread

Cost c1 - c2 lt 0
ST
X2
X1
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Buy a Straddle

• Buy 1 call and 1 put at same strike

X
Cost c p
payout
profit
X
-p-c
X-p-c
Xpc
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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
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Butterfly Spread

• Buy 1 call, sell 2 calls, buy 1 call

X2-X1
payoff
cost
profit
Cost c1 - 2c2 c3
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Bull Spread Using Calls

• Figure 10.2

Profit
X1
X2
ST
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Bull Spread Using Puts
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Bear Spread Using Calls
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Bear Spread Using Puts
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Butterfly Spread Using Calls
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Butterfly Spread Using Puts
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A Straddle Combination
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Strip Strap

• Figure 10.11

Profit
Profit
X
ST
X
ST
Strip
Strap
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A Strangle Combination
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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