Intermediate Options - : Trading Strategies

Intermediate Options – Trading Strategies
Corporate Finance Institute®

Option Fundamentals

Types of Derivative Contracts
Common derivative contracts include forwards, futures, swaps and options.
Forward Commitments Contingent Claims
Forwards Futures Swaps Options

Option Contract Underlying Assets
An option contract derives its value from an underlying asset. A few common underlying assets are:
Options
Stocks Bonds Currencies Commodities Market Indices Interest Rates

Where Options Trade
Exchange Over-The-Counter (OTC)
Standardized contracts that settle through a Contracts are typically customized to match the
clearing house and are guaranteed. specific needs of the parties involved.
The exchange acts as the middle-man Privately negotiated contracts between two
between trading parties. parties without going through an exchange or
other intermediary.
Trades placed electronically or through

Trading parties deal directly with each other.
voice.

CBOE Exchange

Exchange vs. OTC
Exchange Over-The-Counter (OTC)

Pros
• Easy and transparent • No one can see your trade
• High liquidity • Can create bespoke strategies (customize the
• Safe place to trade contract to the investors’ needs)
• No counterparty risk • Flexible on terms
• Price quoted is similar even if traded • Lower transaction costs

within different exchanges • Little to no regulatory oversight
Cons
• Higher cost due to regulatory constraints, • Counterparty risk
exchange fees and commissions
• Hard to access illiquid markets

Why Trade Options
Directional View Portfolio Protection/Hedging
Capitalize on directional views and gain Options can be used to reduce the market
exposure to a security at a lower cost. risk on a specific exposure, underlying
positions, or an entire portfolio.
Income Generation Speculative Trading
Options can enhance the yield on an Options can be used to free up cash flow
underlying share portfolio and generate for other investment opportunities based
income by selling options. on a specific market direction.

What Is an Option
• An option contract gives one party the choice, but not obligation, to buy or sell an underlying asset at
a specific price by or at a specific date.
• If the party that has the right to buy or sell chooses to exercise their option, the counterparty to the
contract must deliver. The two basic options include:
Call Option Put Option
A call option is the choice A put option is the choice

to buy an underlying asset to sell an underlying asset
at a specified price in the at a specified price in the
future. future.

Main Option Components & Terms
1. Underlying Asset 2. Strike Price 3. American vs. European
• Stock, Bond, Currency • The price to exercise your • European: You must wait until
option expiration to exercise the option
• American: Can exercise at any
time before expiration date
4. Expiration Date 5. Contract Size/Multiplier 6. Option Price/Premium

• The last day to exercise • How much of the underlying • The price of the option
your option the contract represents
• Usually 1 contract represents
100 shares

How to Read an Option Ticker/Symbol
GOOG 032020 C 1400
Underlying Name Expiration

Ticker of the underlying security which in this case is This is the expiration date. It is formatted as MM-DD-
Alphabet Inc. YY. The expiration date of this option contract is March
20, 2020.
Call or Put Strike Price

C stands for a call option and a P stands for a put This is the price at which you can exercise the option.
option. Strike prices available are standardized to facilitate
trading and liquidity.

Bloomberg Call Option Example

Underlying asset

Strike price

American vs. European option

Expiration date

Contract size

Option price

Ticker

Liquidity
The ease of trading a security and what is available (supply and demand).
1. Daily Volume of Total Options 2. Total Open Interest 3. Bid/Ask Spread
• Total of both call and put contracts • Number of active contracts for the
underlying name
• Typical minimum daily volume • If you buy 10 calls, the open interest
(contracts) to be considered liquid: will increase by 10
• Selling 4 calls after would lower the

U.S. Canada open interest to 6 (10-4)
1,000 500
• Indicates the number of buyers and
sellers for specific options

Bid/Ask Spread
Market Maker Bid/Ask Spread Trader/Investor
bid offer
5.29 5.75 Spread = Ask – Bid
Spread = $43 – $37 = $6
• Buys at the bid • Buys at the offer/ask

• Sells at the offer/ask • Sells at the bid
The market maker quotes a The trader initiates trades

bid-offer spread at all times. and is a price taker.

Option Mechanics

Call vs. Put Option Mechanics
Buyer
Motivation: Motivation:
• Wants the underlying stock to go up. • Wants the underlying stock to go down.
Note:
What happens up until expiration date? What happens up until expiration date?
For both call and put
options, the buyer’s risk • You have a choice to buy the stock at the • You have a choice to sell the stock at the
is limited to the one- strike price (exercise the option). strike price (exercise the option).
time, up-front cost they When is it profitable? When is it profitable?
pay for the option. • When the stock price by expiration date is • When the stock price by expiration date is
trading above or equal to the strike price. trading below or equal to the strike price.
Seller
Motivation: Motivation:
• Multiple • Multiple
What happens up until expiration date? What happens up until expiration date?
• If the stock price by expiration date is trading • If the stock price by expiration date is trading
above or equal to the strike price, you are below or equal to the strike price, you are
obligated to sell the stock at the strike price. obligated to buy the stock at the strike price.

Moneyness
The relationship between the strike price of the option contract and the price of the underlying security.
When the option’s strike price is When the option’s strike price is
In-the-money below the market price of the above the market price of the
(ITM) underlying asset. underlying asset.
(i.e. There is value to the option) (i.e. There is value to the option)
At-the-money equal to the market price of the equal to the market price of the
(ATM) underlying asset. underlying asset.
Out-of-the- above the market price of the below the market price of the
money (OTM) underlying asset. underlying asset.

Moneyness Bloomberg Example
Current underlying stock

price
Strike Price
Slightly out-of-the-money (near-the-money)

The Value of an Option
Option Price
Intrinsic Value Extrinsic Value
What the option will be worth at expiration (if the The portion of an option’s price driven by time to
stock price is at its current price) expiration and volatility
Remains at expiration Decreases as expiration approaches
Intrinsic Value for Call Option = (Stock Price – • Option may become more valuable before
Strike Price) or 0 (whichever is larger) expiration
• At expiration, options with only extrinsic value
Intrinsic Value for Put Option = (Strike Price – will be worthless
Stock Price) or 0 (whichever is larger)
• Also referred to as an option’s “time value”
Intrinsic Value vs. Extrinsic Value – Call Option
AAPL Stock Price:

$217.73
200 Strike Call Price: $24.52 215 Strike Call Price: $10.40 240 Strike Call Price: $3.20
ITM ATM / Near The Money OTM
Intrinsic Value = 217.73 – 200 = $17.73 Intrinsic Value = 217.73 – 215 = $2.73 Intrinsic Value = 217.73 – 240 = $0.00
Extrinsic Value = 24.52 – 17.73 = $6.79 Extrinsic Value = 10.40 – 2.73 = $7.67 Extrinsic Value = 3.20 – 0.0 = $3.20
Call Option Price = Intrinsic + Extrinsic Value

$120 intrinsic value extrinsic value
$100 ITM ATM OT

M
$80
$60
$40
$20
$0

Intrinsic Value vs. Extrinsic Value – Put Option
AAPL Stock Price:

$217.73
205 Strike Put Price: $6.10 220 Strike Put Price: $12.10 230 Strike Put Price: $17.50
OTM ATM / Near The Money ITM
Intrinsic Value = 205 – 217.73 = $0.0 Intrinsic Value = 220 – 217.73 = $2.27 Intrinsic Value = 230 – 217.73 = $12.27
Extrinsic Value = 6.10 – 0.0 = $6.10 Extrinsic Value = 12.10 – 2.27 = $9.83 Extrinsic Value = 17.50 – 12.27 = $5.23
Put Option Price = Intrinsic + Extrinsic Value

$90 intrinsic value extrinsic value
$80
OT ATM ITM
$70
$60
M
$50
$40
$30
$20
$10
$0

Moneyness Example
Example of call options available for AAPL:
$$$$$ Premium $
Stock Price Deep Deep

= $217.73 ITM ITM ITM ITM ATM OTM OTM OTM OTM OTM
Strike Price
165 200 205 210 215 220 225 230 235 240 260
($)
Cost of
56.99 24.52 19.70 17.10 13.00 10.40 8.18 6.05 4.53 3.20 0.67
Option ($)
Moneyness
74% 92% 94% 97% 99% 101% 104% 106% 108% 111% 122%
(%)

What is Volatility
Volatility is the measure of how much and how quickly the asset’s price changes (measure of uncertainty).
COVID-19
SPX 500 Index (Market Index) Market
3500
Crash:
2020
3000
2500
Dot Com Bubble: Financial Crisis:

2000 1990’s 2008
1500
1000 Black Monday:

The crash of
500 1987
0
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
SPX Price

Historical Volatility vs. Implied Volatility
Historical Volatility Implied Volatility
• Price fluctuations of the underlying asset (ex. • Volatility of the option contract implied by the
stock) market
• Expressed as a percentage • Supply/demand and time value are major
• Usually looked at over a 60-day period factors
• Used to decide if an option is cheap or
expensive

Historical Volatility vs. Implied Volatility – Graph
S&P 500 Historical Volatility COVID-19 Historical vs. Implied Volatility

80.00 70.00
70.00 60.00
60.00
50.00
50.00
40.00
40.00
30.00
30.00
20.00
20.00
10.00
10.00
0.00 0.00
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Jan-20 Feb-20 Mar-20 Apr-20 May-20
Historical Volatility Historical Volatility 3-Month Implied Volatility

S&P 500 Implied Volatility COVID-19 Historical vs. Implied Volatility

70.00 70.00
60.00 60.00
50.00 50.00
40.00 40.00
30.00 30.00
20.00 20.00
10.00 10.00
0.00 0.00
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Jan-20 Feb-20 Mar-20 Apr-20 May-20
3-Month Implied Volatility Historical Volatility 3-Month Implied Volatility

S&P 500 Historical vs. Implied Volatility COVID-19 Historical vs. Implied Volatility
70.00
80.00
70.00 60.00
60.00
50.00
50.00
40.00
40.00
30.00
30.00
20.00 20.00
10.00 10.00
0.00
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 0.00
Jan-20 Feb-20 Mar-20 Apr-20 May-20
Historical Volatility 3-Month Implied Volatility Historical Volatility 3-Month Implied Volatility

Option Greeks Overview
Option Greeks are financial measures of the sensitivity of an option’s price to its underlying determining
parameters.
The rate of change of the option price with respect to the price of the underlying asset.
δ Delta Call option: between 0 and 1 Put option: between -1 and 0
γ Gamma The rate of change of delta with respect to the price of the underlying asset.
ν
The rate of change of the value of the option with respect to the volatility of the
Vega
underlying asset.
θ Theta
The rate of change of the option value with respect to the passage of time with all else
remaining the same (time decay).
ρ Rho The rate of change of the value of the portfolio with respect to the interest rate.

Delta Overview
Delta measures the sensitivity of the option price to a change in the underlying price.
Option Price Call Option Delta Value

High Delta
12
Example Changes
10 Stock price Option contracts

Time to expiration will trade more
8
Volatility sporadically
4
Call (Positive Delta)
∆ Call option price Put (Negative Delta)
Delta =
2 ∆ Stock price
0 10 20 30 40 50 60
Stock Price

Delta Example
September 19 September 20 Change
Stock Price: $28 $30 $2
Option Premium/Cost: $1 $2 $1
Change in Option Price $1

Delta = = = 0.50
Change in Stock Price $2
Delta of 0.50 (often called “50 delta”): Option price moves by half the amount of the stock price move.

Delta Summary

Moneyness Delta Estimate Moneyness Delta Estimate
In-the-money 1.0 In-the-money -1.0
At-the-money 0.5 At-the-money -0.5
Out-of-the-money 0.0 Out-of-the-money 0.0
Delta of a call option For every $1 move in the underlying security,

contract = 0.70 a call option will move UP by $0.70.
Delta of a put option For every $1 move in the underlying security,

contract = -0.70 a put option will move DOWN by $0.70.
• Even if the stock price doesn’t move, delta will change when volatility or time to expiration changes.
• For ATM options, delta is relatively unaffected to changes in volatility or time to expiration.

Delta Bloomberg Example
Underlying Stock Price
Strike Price
Delta
For every $1 stock price move, the option price

will move by $0.48 (strike is near-the-money)

Gamma
Gamma is the second derivative of delta, which measures how fast the delta is changing.
Time to Expiration & Gamma
Gamma (%) With Stock Price at $50
90
Affected by
80 volatility and time
70
to expiration
60 ATM
ITM (put option) ITM (call option)
50 OTM (call option) OTM (put
option)
40
30
20
10
0
30 35 40 45 50 55 60 65 70
Strike Price ($)

Vega
Vega measures the change in option price for each 1% move in implied volatility.
Time to Expiration & Vega
Vega (%) With Stock Price at $50
90
80 ATM
Volatility Goes Volatility Goes
70
Up Down
60
50
Option prices Option prices
40 increase decrease
30
20
10
0
30 35 40 45 50 55 60 65 70
Stock Price ($)

Theta
Theta measures the change in option price as a result of time.
Slow Time Decay
Theta Decreases Theta Increases

Over Time Over Time
Fast Time Decay
Time Premium in
Option Price
Long call option Short call option
Long put option Short put option
ITM/OTM options ATM options
90 days 60 days 30 days 0 (expired)
Days Remaining Until Expiration

Rho
Rho is the measure of the option price change relative to interest rate changes.
$100 Strike Rho vs. Stock Price

Call Rho
0.04 Put Rho
0.03
0.02
$100 Strike Rho
0.01
0
90 95 100 105 110
-0.01
-0.02
-0.03
-0.04
Stock Price

Option Greeks and Pricing
Greek
Increase In Call Price Put Price
Affected
Dividends ρ Decrease Increase
Underlying price δ γ Increase Decrease
Exercise Price Decrease Increase
Time to Expiry θ Increase Increase
Volatility ν Increase Increase
Interest Rate ρ Increase Decrease

Option Strategies

10 Option Trading Strategies
In this course we are going to go over 10 strategies:
Outright Call Covered Outright Put Protective Put Collar

Purchase Call Purchase
Put Writing Call Put Straddle Strangle

Spread Spread

How to Read a Payoff Diagram
Bought 1 share of ABC for $24 + $1 transaction fee.
ABC Stock Chart Payoff Diagram Unlimited

Upside
$27 +$3
Profit = Mkt
Px – Buying Px
$26 – Transaction +$2
Break-even Fee Profit
($/sh+ transaction fee) Break-even
$25 +$1
$24 $0
Loss = Mkt Px $23 $24 $25 $26 $27 $28
– Buying Px –
$23 -$1
Transaction
Fee
$22 Loss -$2
Unlimited
-$3
Today Future Downside

Assumptions & Notes
Assumptions Notes
• Using a made-up company called “ABC” • The strategies will explain the profit and loss
• Using arbitrary prices for examples assuming that you hold the position until
expiration
• No transaction costs
• You don’t always have to exercise an option when
you buy it – you can always close out of a position
• Close Out: If you buy X, you sell X at a later time
at market price
• Cover: If you sell X, you can buy to cover X at a
later time at market price
• When describing downside profit or loss as
unlimited, note that it is technically not infinitely
unlimited (the limit is when the stock price = $0)

Key Terms & Abbreviations
Key Terms Abbreviations
Cost: Net Cost of Trade OTM = Out-of-the-money

• Credit/Prem (Premium) = Money received from the trade ITM = In-the-money
• Debit/Cost = Money paid for the trade ATM = At-the-money
Long: Buy (Bot) | Short: Sell (Sold) Px = Price
Lag/Stall: Trade sideways (the stock doesn’t move up or Mkt = Market (the current stock price)
down drastically, it trades relatively flat)
$/sh = Share Price ($/share)
Rally: When a stock continuously increases in value
@ = “At” (example: the stock is trading @ $26/sh)
Directional View: Expecting the stock price to move only one
NA = Not available or not applicable
way (increase or decrease)
> Greater than
Multiplier: The amount of underlying shares the option can
purchase. 1 contract = 100 shares. Total price will always < Less than
include the multiplier. >= Greater than or equal to
Margin: Money borrowed to purchase an investment <= Less than or equal to
Buying Price: The price you bought the stock at
Outright Call Purchase

Outright Call Purchase – Overview
Strategy:
Buy OTM call option
Motivation:
Gain exposure Bullish view but Reduce exposure Use of leverage

to the stock don’t want to buy but keep potential
shares upside (stock
replacement)

Outright Call Purchase – Example
Strategy Using Stocks Strategy Using Options
ABC Price: $23, Bought: 1 six-month ABC 25 call for $2/contract.
100 ABC Shares: $2,300. Cost: $2/contract * 100 (multiplier) = $200.
ABC Stock ABC 25 Call Option ABC Stock

Right to buy if
stock px > $25
x100 x100
by expiration
$2,300 @ $25/sh before 6
months

Outright Call Purchase – Payoff
Bought 1 six-month ABC 25 call option for $200.

Upside
$29 Break-even
Profit = +$300
(Mkt Px –
$28 Strike Px –
Break-even Cost) * 100
(Strike Price + Option Cost) Profit +$200
$27
Loss = (Mkt
$26 Px – Strike +$100
Px – Cost) + Cost
Strike Price *100
$25 $0 X
$21 $22 $23 $24 $25 $26 $27 $28 $29 $30 $31
$24 Share Price
-$100 Option Cost
$23
Loss = Cost
*100
Loss -$200
$22
Limited
Downside
$21
-$300
$0 Option expires worthless
Today Expiration Date

Outright Call Purchase vs. Buying Stock – What If Analysis
Current ABC Price: $23
Bought: 1 six-month ABC 25 call option for a total cost of $200.
If ABC Stock Increases If ABC Stock Decreases
Strategy Cost Buy & Hold Stock vs. Call Purchase: -5%: -10%: -20%: -30%:
Returns Comparison $21.85 $20.70 $18.40 $16.10
500%
400%
Buy ABC $2 * 100 = 400% 350%
25 Call -$200
Profit / 300% 250%
300%
200% -$200 -$200 -$200 -$200

Option Loss: 200% 150%
100%
100% 50% 39% 43% 48% 52%
17% 0% 22% 26% 30% 35%
Buy ABC $23 * 100 0%
Stock = -$2,300 $27 $28 $29 $30 $31 $32 $33 $34 $35
-$115 -$230 -$460 -$690
Buy & Hold Stock Option Strategy: Buy Outright Call

Outright Call Purchase – Summary
Outright Call Purchase

Initial Cost/Debit (-) Cost of Option
Initial Premium/Credit Received (+) NA
(Money in Hand)
Stock Price >= Strike Price
Max Profit Unlimited
Profit Calculation (Market Px – Strike Px – Option
Cost) * Multiplier
Stock Price < Strike Price
Max Loss Limited
Loss Calculation Cost of Option
Break-Even of Option Strategy
Break-Even Price Strike Px + Option Cost
Note:
• “Market Px” refers to the underlying stock price at the time of (or before) expiration.

Covered Call

Covered Call – Overview
Strategy:
Long underlying stock Sell OTM call option
Motivation:
Yield enhancing Reduce exposure Set an exit point to Can be repeated

strategy (income but keep potential lock-in gains indefinitely
while stock trading upside (rolling strategy)
sideways)

Called Away
Imagine ABC is trading at $23 in October 2019. We own shares and don’t think we will see more than a
10% increase until January 2020.
We sell a 10% OTM call option ($25 strike), expiring in January 2020.
By Expiration Date (January):
Strike
Price
$18 $19 $20 $21 $22 $23 $24 $25 $26 $27 $28 $29 $30 $31 $32
The call option is “called away”

The call option expires worthless. and you are obligated to sell your
stock at $25/sh.
In both situations, you get to keep the premium from selling the call option.

Covered Call – Example
Buy-And-Hold Shares Selling a Call Option Notes
ABC Price: $23, • You don’t expect ABC to rise above $26 or are • Sell 1 call option contract
happy to sell at $26 within the next 6 months. per 100 shares (multiplier)
100 ABC Shares: $2,300.
• $26 is 15% OTM ((26-23)/23) • “Naked”: selling the call
• Sold: 1 six-month ABC 26 call for $1/contract. options but not owning
underlying shares
• Prem: $1/contract * 100 (multiplier) = $100.
• Choice to close or cover
before expiration date
Sell
ABC Stock ABC 26 Call Option ABC Stock
Obligated to sell
if stock px >= $26
x100 x100
by expiration
$2,300 Receive $100 @ $26/sh

Covered Call – Payoff
Bought 100 ABC underlying shares for $23/sh, sold 1 six-month ABC 26 call option for $100.
ABC Stock Chart Payoff Diagram
+$600
Max Profit = Break-even
$28
(Strike Px – +$500
$27 Buying Px + Limited Upside
Strike Price Prem) *100 +$400
$26 Profit
+$300
$25
Profit =
+$200 - Prem
$24 (Mkt Px – Buying
Px + Prem) *100
$23 +$100
$22 $0 X
$21 $14 $16 $18 $20 $22 $24 $26 $28 $30
Break-even -$100
(Share Price - Share Price
$20 Option Cost)
-$200
$19
Loss = (Stock Px
$18 Loss + Prem) * -$300
100 Loss -$400
$17 Unlimited
$16 Downside
-$500
$15 -$600
$0 Option expires worthless
Today Expiration Date ($100 premium received)

Covered Call – Summary
Covered Call
Initial Cost/Debit (-) Cost of Buying Stock
Initial Premium/Credit Received (+) Receive Premium
(Money in Hand) (Option Px * Multiplier)
Max Profit Limited
Profit Calculation (Strike Px – Buying Stock Px +
Premium) * Multiplier
Max Loss Unlimited
Loss Calculation (Market Px – Buying Stock Px +
Premium Received) * Multiplier
Break-Even Price Buying Stock Px – Premium Received
Note:
• “Buying Stock Px” refers to the price you bought the underlying shares at originally.
Outright Put Purchase

Outright Put Purchase – Overview
Strategy:
Buy OTM put option
Motivation:
Limit downside on Lock-in gains Speculative trade on

current holdings a bear market
(“insurance
strategy”)

Outright Put Purchase – Example
Strategy Using Stocks Strategy Using Options
ABC Price: $23, Bought: 1 six-month ABC 20 put for $2/contract.

Short ABC (requires

margin & high risk)
ABC Stock ABC 20 Put Option ABC Stock

Right to sell if
stock px <
x100 $20 x100
by expiration @ $20/sh before 6
$2,300
months

Outright Put Purchase – Payoff
Bought 1 six-month ABC 20 put option for $200.

ABC Stock Chart Unlimited Payoff Diagram
Upside
+$600
$24 Break-even
+$500
$23
Max Loss =
+$400
$22 Cost * 100 Profit
$21 +$300
Strike Price - Cost
$20 +$200
Loss = (Mkt Px –
$19 Break-even
(Strike Price -
Strike Px – Cost) +$100
Option Cost) *100 Share Price
$18
$0 X
$17 $10 $12 $14 $16 $18 $20 $22 $24 $26
-$100
$16 Option Cost
-$200
$15 Limited Downside
Profit = (Strike
$14 Px – Mkt Px – -$300
Cost) *100 Loss -$400
Option expires worthless
$13
$12 -$500
$11
-$600
$0

Outright Put Purchase – Summary
Outright Put Purchase

Initial Cost/Debit (-) Cost of Option
(Money in Hand)
Stock Price <= Strike Price
Profit Calculation (Strike Px – Market Px – Option
Cost) * Multiplier
Stock Price > Strike Price
Max Loss Limited
Loss Calculation Cost of Option * Multiplier
Break-Even Price Strike Px – Option Cost

Protective Put

Protective Put – Overview
Strategy:
Long underlying stock Long OTM put option
Motivation:
Limit downside on Maintain unrealized Lock-in gains Potential to use

current holdings profits and keep dividend payment to
stock fund the purchase
Stop-Loss Order • ABC is trading at $50; you put in a stop-loss order for $40.
Bad market news overnight results in ABC dropping to $30, so your stock sells at $30/share.
Example: •
• The next day the market recovers, and ABC trades again at $50 but you no longer have
shares.
Protective Put – Example
Buy-And-Hold Shares Buying a Put Option Notes
ABC Price: $23, Bought: 1 six-month ABC 20 put for $2/contract. • Could use a stop-loss order
• If stock falls drastically for one
day and bounces, the stop-
loss would trigger and sell
• Protective put is a better
alternative for this reason

Right to sell if
stock px < $20
x100 x100
by expiration
@ $20/sh before 6
$2,300 months

Protective Put – Payoff
Bought 100 ABC underlying shares for $23/sh, bought 1 six-month ABC 20 put option for $200.

+$600 Upside
$28 Break-even
Profit = +$500
$27
(Mkt Px – Buying
+$400
$26 Break-even Px – Cost) *100 Profit
($/sh + Option Cost) +$300
$25
$24 +$200
Loss = + Cost
$23 +$100
(Mkt Px – Buying
$22 Px – Cost) *100 $0 X
$21 $14 $16 $18 $20 $22 $24 $26 $28 $30
Strike Price -$100 Share Price
$20
-$200
$19
$18 Max Loss = -$300
(Strike Px – Loss -$400
$17
Buying Px –
$16 Cost) *100 -$500
Limited
$15 -$600 Downsid
$0 e
Toda Expiration Date Option expires worthless
y
Protective Put vs. Buy-And-Hold Stock – What If Analysis
Current ABC Price: $23
Bought: 100 ABC underlying shares for a total cost of $2,300.
Bought: 1 six-month ABC 20 put option for a total cost of $200.
If ABC Stock Decreases If ABC Stock Increases
Buy & Hold Stock vs. Protective Put: Returns Comparison

60% 52%
48%
43%
39%
40% 35%
30%
26%
22%
17%
20% 13%
9%
4%
0%
0%
$10 $11 $12 $13 $14 $15 $16 $17 $18 $19 $20 $21 $22 $23 $24 $25 $26 $27 $28 $29 $30 $31 $32 $33 $34 $35
-20% -13% -9% -4%
-17%
-22%
-26%
-40% -30%
-35%
-39%
-43%
-60% -48%
-52%
-57%
-80%
Buy & Hold Stock Option Strategy: Protective Put

Protective Put – Summary
Protective Put
Initial Cost/Debit (-) Cost of Option + Cost of Stock
(Money in Hand)
Profit Calculation (Market Px – Buying Stock Px –

Cost) * Multiplier
Max Loss Limited
Loss Calculation (Strike Px – Buying Stock Px – Cost)
* Multiplier
Break-Even Price Buying Stock Px + Option Cost

Collar

Collar – Overview
Strategy:
Long underlying stock Buy OTM put option Sell OTM call option
Motivation:
Reduce cost of Moderately bullish Limited downside Hedge against

protection but fearful of stock market conditions
decline

Collar – Example
Selling a Call Buying a Put

Buy-And-Hold Shares Notes
Option Option
ABC Price: $23, Sold: 1 six-month ABC Bought: 1 six-month ABC • Same % OTM for call & put
25 call for $3/contract. 20 put for $2/contract.
100 ABC Shares: $2,300. • Objective: Put cost is offset
Prem: $3/contract * Cost: $2/contract * 100
by the premium received
100 (multiplier) = $300. (multiplier) = $200.
from selling the call
• “Zero Cost Collar”: A collar
$300 Prem – $200 Cost = $100 Net Credit
strategy with a net cost of 0
Sell
ABC 25 Call Option ABC Stock
Obligation to sell
if stock px >= $25 x100
ABC Stock Receive $300 by expiration @ $25/sh
ABC 20 Put Option ABC Stock

x100 Right to sell if
stock px < $20 x100
$2,300 by expiration @ $20/sh before 6 months

Collar – Payoff
Bought 100 ABC underlying shares for $23/sh, bought 1 six-month ABC 20 put option for $200, sold 1 six-month
ABC 25 call option for $300; net debit/credit: +$1
$28 Max Profit = Break-even
+$500
(Call Strike –
$27
Buying Px + Net +$400
$26 Credit/
Limited Upside
Call Strike (C) – Net Debit) *100 Profit +$300
$25
- Net
Profit =
$24 +$200 Credit
(Mkt Px – Buying
$23 Px + Net Credit/ -
+$100
Net Debit) *100
$22
Break-even (Buying Px – Mkt $0 P C
$21 (Buying Px - Net Px – Net Credit/ $14 $16 $18 $20 $22 $24 $26 $28 $30
Credit/+Net Debit)
+ Net Debit) -$100 Share Price
$20 *100
Put Strike (P) -$200
$19 Limited Downside
Max Loss = -$300
$18 Loss
(Buying Px – Put
$17 Strike – Net -$400
Credit/ + Net Call option expires worthless
$16 Debit) *100 -$500
Put option expires worthless
$15
$0

Collar – Summary
Note: Collar results in either a net credit/premium or a net debit/cost

Collar
Initial Cost/Debit (-) Cost of Put Option + Cost of Stock
Initial Premium/Credit Received (+) Cost of Call Option
(Money in Hand)
Stock Price >= Call Strike Price
Max Profit Limited
Profit Calculation (Call Strike Px – Buying Stock Px + Net Credit) * Multiplier
OR
(Call Strike Px – Buying Stock Px – Net Debit) * Multiplier
Stock Price <= Put Strike Price
Max Loss Limited
Loss Calculation (Buying Stock Px – Put Strike Px – Net Credit) * Multiplier
OR
(Buying Stock Px – Put Strike Px + Net Debit) * Multiplier
Break-Even Price Buying Stock Px + Put Strike Px – Call Strike Px

Put Writing

Put Writing – Overview
Strategy:
Sell OTM put option Cash-secured: cash equivalent of buying the stock
(cash-secured) • Put Strike * Number of Contracts * Multiplier
Motivation:
Yield enhancing
Arrange one or Increase existing
strategy (stock
multiple lower entry stock position at a
trading sideways or
prices lower price
increasing)

Being Assigned
Imagine XYZ is trading at $50 in October 2019. We own shares and don’t think we will see more than a
10% decrease until January 2020.
We sell a 10% OTM put option ($45 strike), expiring in January 2020.
By Expiration Date (January):
Strike
Price
$38 $39 $40 $41 $42 $43 $44 $45 $46 $47 $48 $49 $50 $51 $52
The put option is “assigned” and

you are obligated to purchase The put option expires worthless.
your stock at $45/sh.
In both situations, you get to keep the premium from selling the put option.

Put Writing – Example
Buy-And-Hold Shares Selling a Put Option Notes
ABC Price: $23, Sold: 1 six-month ABC 19 put for $1/contract. • Similar to buying the stock
100 ABC Shares: $2,300. Prem: $1/contract * 100 (multiplier) = $100. at a discount
• “Naked”: selling the put
option but not securing it
with cash
• Cash-collateralized: you
put up money to cover the
underlying shares
Sell
Obligated to buy
if stock px <= $19
x100 x100
by expiration
$2,300 Receive $100 @ $19/sh

Put Writing – Payoff
Sold 1 six-month ABC 19 put option for $100.

+$600
$24 Break-even
+$500
$23
+$400
$22 Max Profit = Profit
Prem * 100 +$300
$21
$20 +$200 - Prem
Strike Price Limited Upside
$19 (Mkt Px – Strike Px + +$100
Prem) Prem Received
$18
Break-even
$0 X
$17 (Strike Price - $10 $12 $14 $16 $18 $20 $22 $24 $26
Option Prem) -$100
Share Price
$16
-$200
$15
Loss = (Mkt Px – -$300
$14 Strike Px + Prem)
*100 Loss -$400
$13
-$500
$12
$11 -$600
$0 Unlimited Option expires worthless

Today Expiration Date Downside ($100 premium received)

Put Writing – Summary
Put Writing
Initial Cost/Debit (-)
Initial Premium/Credit Received (+) Premium Received
(Money in Hand)
Max Profit Limited
Profit Calculation Premium Received * Multiplier
Max Loss Unlimited
Loss Calculation (Market Px – Put Strike Px +
Premium Received) * Multiplier
Break-Even Price Strike Px – Premium Received

Bull Call Spread

Bull Call Spread – Overview
Strategy:
Buy ATM call option Sell OTM call option
Motivation:
Outright call options Moderately bullish Risk limited to the

Use of leverage
are too expensive (expect stock price cost of the call
increase) spread

Bull Call Spread – Example
Buying a Call Selling a Call

Buy-And-Hold Shares Notes
Option Option
ABC Price: $23, Bought: 1 six-month ABC Sold: 1 six-month ABC

24 call for $3/contract. 27 call for $1/contract. • Sell an OTM call option to
100 ABC Shares: $2,300.
Cost: $3/contract * 100 Prem: $1/contract * fund the purchase of an
(multiplier) = $300. 100 (multiplier) = $100. ATM call option
$300 Cost – $100 Prem = $200

ABC 24 Call Option Right to buy if ABC Stock
stock px > $24
ABC Stock x100
by expiration @ $24/sh before 6 months
x100 Sell
ABC 27 Call Option Obligated to sell ABC Stock
$2,300 if stock px <= $27
x100
Receive $100 by expiration
@ $27/sh

Bull Call Spread – Payoff
Bought 1 six-month ABC 24 call option (X1) for $300, sold 1 six-month ABC 27 call option (X2) for $100; net cost of trade: $200.

+$300
$30
+$250 Break-even
Profit =
$29
(X2 – X1 – Cost) +$200
$28 *100 Profit
Call Strike (X2) +$150
$27
Profit/Loss = Limited Upside
Break-even
$26 +$100
(Call Strike Bought + (Mkt Px – X1 – + Cost
Net Cost of Trade)
$25 Cost) *100 +$50
Call Strike (X1)
$24
$0 X1 X2
$23 $16 $18 $20 $22 $24 $26 $28 $30 $32
-$50 Share
$22 Price
$21
-$100 Cost of Trade
Max Loss = -$150
$20
Net Cost of
Trade
Loss -$200
$19
Limited Downside
$18 -$250
$17
-$300 Both call options expire
$0 worthless
Toda Expiration Date
y
Bull Call Spread – Summary
Bull Call Spread

Initial Cost/Debit (-) Lower Strike Call Px – Upper Strike Call Px
Initial Premium/Credit Received (+) (Money in Hand) NA
Stock Price >= Upper Strike Price

Profit Calculation (Upper Strike – Lower Strike – Net Cost) * Multiplier
Max Profit Limited

Stock Price < Lower Strike Price
Max Loss Limited
Loss Calculation Net Cost (Cost of Spread) * Multiplier
Break-Even Price Lower Strike Px + Net Cost
Note:
• Bought: Lower Strike Call, Sold: Upper Strike Call
• “Net Cost (Cost of Spread)” = Lower Strike Call Px – Upper Strike Call Px
Bear Put Spread

Bear Put Spread – Overview
Strategy:
Sell 90% OTM put option Buy ATM put option
Motivation:
Bearish but targeted Using margin to Risk limited to the

Use of leverage
view short the underlying cost of the put
is expensive spread

Bear Put Spread – Example
Shorting Stock Buying a Put Option Selling a Put Option
ABC Price: $23, Bought: 1 six-month ABC 22 Sold: 1 six-month ABC 18

100 ABC Shares: $2,300. put for $2.50/contract. put for $1/contract.
Cost: $2.50/contract * 100 Prem: $1/contract * 100
(multiplier) = $250. (multiplier) = $100.
Short ABC (requires

margin & high risk) $250 Cost – $100 Prem = $150
ABC 22 Put Option Right to sell if

ABC Stock
stock px < $22
ABC Stock x100
by expiration
@ $22/sh before 6 months
x100 Sell
Obligated to buy
$2,300 if stock px >= $18
x100
Receive $100 by expiration
@ $18/sh

Bear Put Spread – Payoff
Bought 1 six-month ABC 22 put option (X1) for $250, sold 1 six-month ABC 18 put option (X2) for $100; net cost of trade: $150.

+$300
$28 Limited Upside
+$250 Break-even
$27
+$200
$26 Profit
Max Loss =
$25 +$150
Net Cost of
Trade +$100
$24 - Cost
$23 +$50
Put Bought (X1) Share Price
$22
(Mkt Px – X2 – Cost) $0 X2 X1
$21 Break-even *100 $14 $16 $18 $20 $22 $24 $26 $28 $30
-$50
$20 (Put Strike Bought -
Net Cost of Trade)
Cost of Trade
(X1 – Mkt Px – -$100
$19 Cost) *100
Put Sold (X2) -$150
$18
Loss Limited Downside
$17 -$200
Max Profit =
$16 (X1 – X2 – Cost] -$250 Both put options expire worthless
*100
$15
-$300
$0

Bear Put Spread – Summary
Bear Put Spread

Initial Cost/Debit (-) Upper Strike Put Px – Lower Strike Put
Px
(Money in Hand) Stock Price <= Lower Strike Price
Max Profit Limited
Profit Calculation (Upper Strike – Lower Strike – Net Cost)
* Multiplier
Stock Price > Upper Strike Price
Max Loss Limited
Loss Calculation Net Cost (Cost of Spread) * Multiplier
Break-Even Price Upper Strike Px – Net Cost
Note:
• Bought: Upper Strike Put, Sold: Lower Strike Put
• “Net Cost (Cost of Spread)” = Upper Strike Put Px – Lower Strike Put Px
Straddle

Straddle – Overview
Strategy:
Buy ATM put option Buy ATM call option
Motivation:
Expecting high Neutral view on Speculative trade Risk limited to the

volatility for stock (no directional cost of trade
underlying stock bias)

Straddle – Example
Buying a Call Option Buying a Put Option Notes
Bought: 1 six-month ABC Bought: 1 six-month ABC

23 call for $3.50/contract. 23 put for $2.50/contract. • Expecting large stock price
movement due to future
Cost: $3.50/contract * 100 Cost: $2/contract * 100
event
• Examples: product release
$350 Cost + $250 Cost = $600 or upcoming merger
ABC 23 Call Option Right to buy if

ABC Stock
stock px > $23 x100

Right to sell if
stock px < $23 x100

Straddle – Payoff
Bought 1 six-month ABC 23 put option (X), bought 1 six-month ABC 23 call option (X); net cost of trade: $600.

+$600
$35 Break-even Break-even
Unlimited Unlimited
+$500 (Lower) (Upper)
$33 Profit = (Mkt Px Upside Upside
– X – Cost) *100 +$400
$31 Break-even (Upper) Profit
$29
(Strike Px + Cost of Trade) +$300
$27 (Mkt Px – X – +$200

- Cost + Cost
$25 Cost) *100
Max +$100
$23 Loss
Call/Put ($600)
$0 X
$21 Strike (X) $7 $11 $15 $19 $23 $27 $31 $35 $39
(X – Mkt Px – -$100
Cost) *100 Share Price
$19
-$200
$17
Break-even -$300
$15 (Lower)
(Strike Px - Cost of Profit = Loss -$400
$13 Trade)
(X – Mkt Px –
$11 Cost) -$500
*100
$9 -$600
Max Loss
$0
Today Expiration Date Call expires worthless Put expires worthless

Straddle – Summary
Straddle
Initial Cost/Debit (-) Call Px + Put Px
Stock Price > Upper Break-Even Price OR Stock Price < Lower Break-Even Price
Profit Calculation [|(Strike Price – Market Px)| – Cost of Trade] * Multiplier
Stock Price = Strike Price
Max Loss Limited
Loss Calculation Cost of Trade * Multiplier
Upper Break-Even Price Strike Px + Cost of Trade
Lower Break-Even Price Strike Px – Cost of Trade
Note:
• Profit: Absolute value (||) is used since the strategy makes money if the stock increases or decreases
• Cost of Trade = Call Px + Put Px

Strangle

Strangle – Overview
Strategy:
Buy OTM put option Buy OTM call option
Motivation:
Expecting high Directional view on Speculative trade Risk limited to the

volatility for stock cost of trade
underlying stock

Strangle – Example
Buying a Call Option Buying a Put Option Notes
Bought: 1 six-month ABC 24 Bought: 1 six-month ABC 18

• Typically cheaper than
call for $2.50/contract. put for $0.50/contract.
straddle (betting on a
Cost: $2.50/contract * 100 Cost: $0.50/contract * 100
direction)
• Expecting a significant move
$250 Cost + $50 Cost = $300 based on future expected
events
ABC 24 Call Option ABC Stock

Right to buy if
stock px > $24 x100

Right to sell if
stock px < $18 x100
by expiration @ $18/sh before 6
months
Strangle – Payoff
Bought 1 six-month ABC 18 put option (P), bought 1 six-month ABC 24 call option (C); net cost of trade: $300.

+$600
$35 Break-even Break-even
+$500
$33 (Lower) (Upper)
Profit = (Mkt Px
– Call Strike – +$400
$31 Profit
Cost) *100
$29 Break-even (Upper) +$300
Unlimited Unlimited
(Call Strike + Cost of Trade)
$27 +$200 Upside Upside
- Cost + Cost
$25 Call Strike (C) +$100
$23
$0 P C
$21 Max Loss = Cost $7 $11 $15 $19 $23 $27 $31 $35 $39
of Trade -$100
$19
Cost of Share
Put Strike (P) Price
-$200 Trade
$17
$15 -$300
Break-even Loss
$13 (Lower) -$400
Profit =
(Put Strike - Cost
$11 of Trade) (Put Strike – Mkt -$500
Px – Cost) *100
$9 Put expires worthless
-$600
$0
Today Expiration Date Call expires worthless

Strangle – Summary
Strangle
Initial Cost/Debit (-) Call Px + Put Px
Stock Price > Upper Break-Even Price OR Stock Price < Lower Break-Even Price
Profit Calculation (Upside) (Market Px – Call Strike Px – Cost of Trade) * Multiplier
Profit Calculation (Downside) (Put Strike Px – Market Px – Cost of Trade) * Multiplier
Put Strike Price >= Stock Price <= Call Strike Price
Max Loss Limited
Loss Calculation Cost of Trade * Multiplier
Break Even of Option Strategy
Upper Break Even price: Call Strike Px + Cost of Trade
Lower Break Even Price Put Strike Px – Cost of Trade
Note:
• Cost of Trade = Call Px + Put Px; Different Strikes
Course Summary

Course Summary
Outright Call Covered Outright Put Protective Put Collar

Purchase Call Purchase
Put Writing Call Put Straddle Strangle

Spread Spread

Course Summary
You should now be able to:
• Describe the key derivative concepts and terms

• Understand how options traded OTC differ from exchange-traded options
• Identify moneyness with respect to an option
• Understand the intrinsic and extrinsic values of an option
• Explain the importance of volatility for options
• Define the option Greeks
• Evaluate various option strategies and identify when you use each
Understanding how to use option trading strategies is

essential when making investment and trading decisions

Intermediate Options - : Trading Strategies

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Intermediate Options - : Trading Strategies

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Intermediate Options – Trading Strategies

Corporate Finance Institute®

Corporate Finance Institute®

Common derivative contracts include forwards, futures, swaps and options.

Forward Commitments Contingent Claims

Forwards Futures Swaps Options

Corporate Finance Institute®

Stocks Bonds Currencies Commodities Market Indices Interest Rates

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Exchange Over-The-Counter (OTC)

Trades placed electronically or through

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Corporate Finance Institute®

Exchange Over-The-Counter (OTC)

• No counterparty risk • Flexible on terms

• Price quoted is similar even if traded • Lower transaction costs

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Directional View Portfolio Protection/Hedging

Income Generation Speculative Trading

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Call Option Put Option

A call option is the choice A put option is the choice

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1. Underlying Asset 2. Strike Price 3. American vs. European

4. Expiration Date 5. Contract Size/Multiplier 6. Option Price/Premium

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GOOG 032020 C 1400

Underlying Name Expiration

Call or Put Strike Price

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Corporate Finance Institute®

Corporate Finance Institute®

Corporate Finance Institute®

American vs. European option

Corporate Finance Institute®

Corporate Finance Institute®

Corporate Finance Institute®

Corporate Finance Institute®

Corporate Finance Institute®

1. Daily Volume of Total Options 2. Total Open Interest 3. Bid/Ask Spread

• Selling 4 calls after would lower the

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Market Maker Bid/Ask Spread Trader/Investor

Spread = $43 – $37 = $6

• Buys at the bid • Buys at the offer/ask

The market maker quotes a The trader initiates trades

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Corporate Finance Institute®

Call Option Put Option

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Call Option Put Option

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Current underlying stock

Slightly out-of-the-money (near-the-money)

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Intrinsic Value Extrinsic Value

Remains at expiration Decreases as expiration approaches

AAPL Stock Price:

Call Option Price = Intrinsic + Extrinsic Value

$100 ITM ATM OT

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AAPL Stock Price:

Put Option Price = Intrinsic + Extrinsic Value