Trading Strategies Involving Options

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Trading Strategies Involving Options
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Butterfly Spread

• A butterfly spread involves positions in options
  with three different strike prices. It can be
  created by buying two options with low and high
  strike prices and selling two options with a
  strike price halfway between low and high strike
  prices.
• It leads to a small profit if futures price stay
  close to selling strike price but makes small
  loss if there is a significant futures price move
  in either direction.

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Butterfly Spread Using Puts
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Butterfly Spread Using Calls
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• Call options on a stock are available with strike
  prices of 15, 17.5, and 20 and expiration
  dates in three months. Their prices are 4, 2,
  and 0.5, respectively. Explain how the options
  can be used to create a butterfly spread.
  Construct a table showing how profit varies with
  stock price for the butterfly spread.

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Calendar Spread

• A calendar spread can be created by selling a
  call option with a certain strike price and
  buying a longer maturity call option with the
  same strike price.

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Calendar Spread Using Calls
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Calendar Spread Using Puts

• Figure 9.9 (p.226)

Profit
ST
X
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Combinations

• A combination is a strategy that involves taking
  a position in both calls and puts on the same
  stock.
  
• There are different types of combinations
• Straddle Can be created by buying both a put and
  a call with a strike price close to current
  selling price. A straddle is appropriate strategy
  if the investor is expecting a large move in a
  stock price in either direction. This is also
  called as a bottom straddle or straddle purchase.

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A Straddle Combination
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Problem

• Consider an investor who feels that the price of
  a certain stock, currently, valued at 69 by the
  market, will move significantly in the next three
  months. The investor could create a straddle by
  buying a put and a call with a strike price of
  70 and an expiration date in three months.
  Suppose that the call costs 4 and the put costs
  3. What is the pattern of profit from the
  straddle?

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Combinations

• Similarly, a top straddle can be created by
  selling a call and a put with the same exercise
  price and expiration date.
  
• This strategy results in profit if the stock
  price on the expiration date is close to the
  strike price.
  
• A large move in either direction results in
  significant loss.

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Combinations

• Strip A strip strategy includes a long position
  in one call and two puts with the same strike
  price and expiration date.
  
• In a strip, investor believes that there is more
  likelihood of price to decrease than increase.
  
• Strap A strap includes a long position in two
  calls and one put with same strike price and
  expiration date.
  
• Investor is betting a increase in the stock price
  more likely than a decrease.

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Strip Strap

• Figure 9.11 (p. 229)

Profit
Profit
X
ST
X
ST
Strip
Strap
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Combinations

• Strangles Includes a long in call and put with
  the same expiration date and different strike
  price.
  
• This is similar to strangle strategy. The use of
  two different strike price reduces the downward
  risks.

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A Strangle Combination
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Payoff from a straddle

• A call with a strike price of 60 costs 6. A put
  with the same strike price and expiration date
  costs 4. Construct a table that shows the profit
  from a straddle. For what range of stock prices
  would the straddle lead to a loss?

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• Three put options on a stock have the same
  expiration date and strike prices of 55, 60,
  and 65. The market prices are 3, 5, and 8,
  respectively. Explain how a butterfly spread can
  be created. Construct a table showing the profit
  from the strategy. For what range of stock prices
  would the butterfly spread lead to a loss?