Option Trading Strategies - Part 2

Chapter 12
Trading Strategies Involving

Options
Options, Futures, and Other Derivatives, 9th Edition,

Copyright © John C. Hull 2014 1
Strategies to be Considered
Bond plus option to create principal
protected note
Stock plus option
Two or more options of the same type (a
spread)
Two or more options of different types (a
combination)

Principal Protected Note
Allows investor to take a risky position without
risking any principal
Example: $1000 instrument consisting of
3-year zero-coupon bond with principal of $1000
3-year at-the-money call option on a stock portfolio
currently worth $1000
Suppose that the 3-year interest rate is 6% with continuous compounding.
3-year at-the-money European call option premium is less than $164.73.

Principal Protected Notes
Propose strategy if stock price is expected to
be fallen? Calculate payoff.

Principal Protected Notes continued
Viability depends on
Level of dividends
Level of interest rates
Volatility of the portfolio
Variations on standard product
Out of the money strike price
Caps on investor return
Knock outs, averaging features, etc

Positions in an Option & the Underlying
(Figure 12.1, page 257)
Profit Profit
K
K ST ST
(a)
(b
Profit Profit )
K
Married Put ST K ST
(c (d
Options,)Futures, and Other Derivatives, 9th Edition, )
Bull spread
What is bull spread strategy?
What is the purpose of Bull spread strategy
What do you conclude from the two diagrams
above?

A spread trading strategy involves taking a
position in two or more options of the
sametype (i.e., two or more calls or two or
more puts).
BULL BEAR
SPREAD SPREAD

Bull Spread Using Calls
(Figure 12.2, page 258)
Profit
ST
K1 K2

Bull Spread Using Puts
Figure 12.3, page 259
Profit
K1 K2 ST

Bull spread
Bull spread is an optimistic option strategy to
gain profit from a moderate rise of assets’ prices.
Bull spread strategy is design by simultaneously
using long call (put) and short call (put) with the
same maturity, same underlying asset but
different strike price (vertical spread).
Purchasing a call with a lower strike price than
the written call provides a bullish strategy.

Bull spread
Bull call spread or Bull put spread but the
option purchased (long premium) costs more
than the option sold (put premium).
Bull spreads are not suited for every market
condition. They work best in markets where
the underlying asset is rising moderately and
not making large price jumps.
The loss and profit are limited in bull spread
strategy.
Example 1: Bull
An investor utilizes a bull call spread by purchasing a call
option for a premium of $10. The call option comes with a
strike price of $50 and expires in July 2020. At the same
time, the investor sells a call option for a premium of $3.
The call option comes with a strike price of $70 and
expires in July 2020. The underlying asset is the same
and is currently trading at $50.
Calculate the payoff of this strategies.

Bear Spread Using Puts
Profit
K1 K2 ST

Bear Spread Using Calls
Profit
K1 K2 ST

Bear Spread
Bear spread is an optimistic option strategy to
gain profit from a moderate reduce of assets.
Bear spread strategy is design by simultaneously
using long call (put) and short call (put) with the
same maturity, same underlying asset but
different strike price (vertical spread).
Purchasing a call (put) with a higher strike price
than the written call (put) provides a bearish
strategy.
Example 2: Bear Call
Let's assume that a stock is trading at $30. An
options trader can use a bear call spread by
purchasing one call option contract with a strike
price of $35 and a cost of $0.50 and selling one
call option contract with a strike price of $30 for
$2.50. Given that we have 100 shares/option
contract).

LC
2.5
2.0
35
St
30
-0.5
-3.0
SC

200
-300

Bull vs Bear

Example 3: Bear Put
Assume the strategy that we’ll buy the 130
put for $5.00 and sell the 120 put for $2.00.
Let's also say that the stock price is trading
for $135 at the time of buying the spread.

Example 3: Bear Put
Initial Stock Price: $135
Put Options Traded: Buy 130 put for $5.00; Sell
120 put for $2.00
Put Spread Purchase Price: $5.00 Paid - $2.00
Received = $3.00 Net Debit

https://www.projectoption.com/wp-content/upl
oads/2016/10/Bear_Put_Spread_Risk_Graph
.svg?x34254

Box Spread
A combination of a bull call spread and
a bear put spread
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 (see Business Snapshot
11.1)
Box spread

Butterfly Spread
Butterfly spreads use four option contracts
with the same expiration but three different
strike prices. A higher strike price, an
at-the-money strike price, and a lower strike
price.

Butterfly Spread Using Calls
Profit
K1 K2 K3 ST

The long butterfly call spread is created by
buying one in-the-money call option with a
low strike price, writing two at-the-money call
options, and buying one out-of-the-money call
option with a higher strike price.

Butterfly Spread Using Puts
Profit
K1 K2 K3 ST

Calendar Spread Using Calls
Profit
ST
K

Calendar Spread Using Puts
Profit
ST
K

A Straddle Combination
Profit
K ST

Strip & Strap
Profit Profit
K ST K ST
Strip Strap
A Strangle Combination
Profit
K1 K2
ST

Other Payoff Patterns
When the strike prices are close together a
butterfly spread provides a payoff consisting
of a small “spike”
If options with all strike prices were available
any payoff pattern could (at least
approximately) be created by combining the
spikes obtained from different butterfly
spreads


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Chapter 12

Trading Strategies Involving

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

Options, Futures, and Other Derivatives, 9th Edition,

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