Option Trading

Strategies

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Motivation for Trading Strategies
• Trading strategies for obtaining desired
benefits and protection from market
movement direction

• Full benefit from upward movement with

no protection from downward movement
– Long underlying/forward

• Full benefit from upward movement with

protection from downward movement
– Long call
PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das
 Motivation for Trading Strategies
• Full benefit from downward movement
with no protection from upward
movement
– Short underlying/forward

• Full benefit from downward movement

with protection from upward movement
– Long put

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Motivation for Trading Strategies (contd.)
• Trader may be willing to limit extent of
benefit and protection in return for
reduced cost of taking position

• May have a view on the market in terms

of direction and/or volatility and would
like to take a cost efficient position
aligned with that view

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Strategies to be Considered
• Bond plus option to create principal
protected note
• Underlying asset plus option on it
• Two or more options of the same
type (a spread)
• Two or more options of different
types (a combination)

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Principal Protected Note
• Allows investor to take a risky position
without risking any principal
• Example: USD1000 instrument
consisting of
– 3-year zero-coupon bond with
principal of USD1000 (costs less
than USD1000)
– Balance of $1000 to buy 3-year at-
the-money call option on a portfolio
PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das
 Positions in an Option & the Underlying

Payoff Payoff

K
K ST ST

Payoff Payoff

K
ST K ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Bull Spread Using Calls

Payoff

ST
K1 K2

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Bull Spread Using Puts

Payoff

K1 K2 ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Bear Spread Using Puts

Payoff

K1 K2 ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Bear Spread Using Calls

Payoff

K1 K2 ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Butterfly Spread Using Calls

Payoff

K1 K2 K3 ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Butterfly Spread Using Puts

Payoff

K1 K2 K3 ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Long Straddle -
Combination
Payoff

K ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das

 Long Strangle -
Combination
Payoff

K1 K2
ST

PGDM (B&FS) 2021-2023 Financial Derivatives - II Himadri Das