Option

Strategies

Majid Ghanipour, CFA

Majid Ghanipour, CFA 1

 Options, Risk Graphs

Long Stock Long Put Long Call

Short Stock Short Put Short Call

Majid Ghanipour, CFA 2
 Options, Synthetics
Synthetic long stock (forward) Synthetic short stock (forward)

Long Call Long Put

Long Call
Long Put

Short Put Short Call Short Put Short Call

Synthetic Put Synthetic Call

Short Stock Long Stock
+ +
Long Call Long Put

Maybe cheaper than call/put itself

Majid Ghanipour, CFA 3
 Covered Call
Short calls on long stocks. Why?
1) Generate income

2) Reducing a Position at a Favorable Price (sell ITM calls, stock ABC @ $20, and we
want to sell it now, instead, we could sell $15 calls => we earn $5 + TV now and $15 @
expiration)

3) Target price realization (sell near-term calls with strike price equal to the underlying’s
target price, if not exercised, the next near-term call option)

Profit/Loss
Max gain:
Max gain = (X – S0) + C0 X + C – S0

BEP: S0 – C0
BEP: called away
@ expiration: S0 – C

Value: Min (ST,X) call is worthless

Profit: Min (ST,X) – S0 + C0

Majid Ghanipour, CFA 4

 Protective Put
Long puts on long stocks. Why?
To protect against losses.

It is like a synthetic call. One side of put–call parity.

In long puts, buy more time than needed since options does not decay linearly.

Profit/Loss
Max loss = (S0 – X) + P
put is worthless
BEP: S0 + P
@ expiration: BEP:
putted away
S0 + P
Value: Max (ST,X)
Profit: Max (ST,X) – S0 + P Max loss:
S0 – X + P

Majid Ghanipour, CFA 5

 Collars
Long put, Short Call on long stocks. (Protective Put + Covered Call) Why?
Implemented when the investor requires downside protection for the short- to medium-
term, but at a lower cost. Protective collars are particularly useful when the broad
markets or specific stocks are showing signs of retreating after a sizable advance.

Both options are OTM

XP < St < XC
St is the current stock price (when the collar is established)
Max gain:
XC is the target price, XP is the stop loss price (XC – S0) + net premium paid *
Purchase of the put is financed with the sale of the call
C is Called

Max loss (min profit):

(S0 – XP) + net premium paid *
P is Putted
Majid Ghanipour, CFA * net premium paid = (C – P) 6
 Collars
A zero-cost collar involves the purchase of a put and sale of a call with the
same premium.
There is one specific call with the same premium, and it has a particular exercise price,
which is above the exercise price of the put.

Same-strike Collar:
Long put + short call with same strike + long stock

Long put + short call = synthetic short position

A completely neutralized position

A delta neutral position

Alternative (Short collar):

Short put, Long Call, and short stock

Majid Ghanipour, CFA 7

 Bull spread
Bull/bear spreads are delta plays

Either with 2 puts or 2 calls (hint: buy low sell high)

No position in the underlying
Benefit from two factors, a rising stock price and time decay of short option.

Can be constructed as:

Buy a call XL, and sell a call XH (debit spread = net outflow of premium)
Buy a put XL, and sell a put XH (credit spread = net inflow of premium)

A bull call/put spread rises in price as the stock price rises and declines as the
stock price falls. This means that the position has a “net positive delta”, “near-zero
gamma”, and “near-zero vega”

To determine the BEP with a spread, find the underlying asset price that will
cause the exercise (CL, PH) value of the two options combined to equal the initial
cost of the spread.

Majid Ghanipour, CFA 8

 Bull spread
Max gain:
Bull call spread (XH – XL) – net premium paid

Short CallH BEP: Both are called

XL + net premium paid

Long CallL Help finance

(net premium paid) Max loss:
net premium paid
(CL – CH)
Both calls are worthless

Bull put spread Max gain:

net premium received
(PH – PL)
Short PutH
BEP: Both puts are worthless
XH - net premium received

Long PutL Help finance

(net premium received)
Max loss:
(XH – XL) – net premium received

Both are putted

Majid Ghanipour, CFA * long stock position is created 9
 Bear spread
Either with 2 puts or 2 calls (hint: buy high sell low)
No position in the underlying

Benefit from two factors, a decreasing stock price and time decay

Can be constructed as:

Sell a call XL, and buy a call XH (credit spread = net inflow of premium)

Sell a put XL, and buy a put XH (debit spread = net outflow of premium)

A bear call/put spread benefits when the underlying price falls and is hurt when
it rises. This means that the position has a “net negative delta”, “near-zero
gamma”, and “near-zero vega”

Majid Ghanipour, CFA 10

 Bear spread
Max gain:
Bear call spread net premium received
(CL – CH)
Long CallH BEP:
Both calls are worthless
XL + net premium received

Short CallL Help finance

(net premium received)
Max loss:
(XH – XL) – net premium received

Both are called

Bear put spread Max gain:

(XH – XL) – net premium paid
Long PutH BEP:
Both are putted
XH – net premium paid

Short PutL Help finance

(net premium paid)
Max loss:
net premium paid
(PH – PL)
Both Puts are worthless
Majid Ghanipour, CFA 11
 Straddle
Long a call, Long a put, both same exercise price
No position in the underlying

It is a vega play. The long straddle trade is said to be long volatility.

The long straddle is a bet that increased volatility will move the stock price strongly above or
below the strike price.
If puts and calls have different exercise prices, the position is a strangle

Short straddle: Short a call, Short a put; (anticipation: decreasing volatility)

Done when a price outcome is uncertain, but volatility is not

Delta = -1 Delta = +1

BEP: X – (P + C) BEP: X + (P + C)

Putted Called
Max loss:
P+C
Majid Ghanipour, CFA 12
 Calendar spread
Taking advantage of time decay is a primary motivation behind a calendar
spread
It is a theta play
Distant option is more expensive than the near-term one (time decay)
Time decay is more pronounced for short-term option than for longer

Sell/buy same type of options but with different expiration dates

Same strike price
Both the profit potential and risk are limited.
Long calendar spread (positive theta)
Sell near-term call/put, Buy distant call/put
A long calendar spread is used when the investment outlook is flat in the near term but greater
return movements are expected in the future.
Short calendar spread (negative theta)
Buy near-term call/put, Sell distant call/put
A short calendar spread is used when the investment outlook is volatile in the near term but
lesser return movements are expected in the future.

Majid Ghanipour, CFA 13

 Calendar spread
Calendar spread has near-zero delta

Worthless expiration of near-term option is a good outcome for the calendar

spread trader

Thetas for ITM calls provide motivation for a short calendar spread.

Calendar spreads are sensitive to movement of the underlying but also

sensitive to changes in implied volatility.
In long calendar spread, the belief is that the premium on the shorter should fall faster
(gain more) than the premium on the longer (lose less).
Both options are either calls (if bullish) or puts (if bearish).
A long calendar spread will benefit from a stable market or an increase in implied volatility.
Assuming the options are sufficiently ITM or OTM, the thetas are relatively higher for
longer options so the belief is that the longer options will lose time value more rapidly,
therefore resulting in a gain.
The writer of a calendar spread is looking for a large move away from the strike price in either
direction or a decrease in implied volatility.

Majid Ghanipour, CFA 14