4 4 Advanced Option Strategies

8/14/2019 4 4 Advanced Option Strategies

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Advanced Option Strategies

Derivatives and Risk Management


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Outline

Principles of Money Spreads and combinations

Bull spread

Bear spread

Butterfly Spread Calendar spreads

Combinations

Collars

Straddle Strips and straps

strangles


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Option Spreads

What do we mean by a spread?

Types of Spreads

Vertical/Money Spread

Horizontal Spread

Buying the Spread

Selling the Spread

Why use spreads?


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Money Spreads

Bull Spreads

Bear Spreads


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Bull Spread

Creating Bull spread with calls

Buy a call option on a stock with a certain

exercise price and sell a call option on the same

stock with a higher exercise price Example

Creating Bull spread with puts

Buy a put with a low strike price and sell a put witha high strike price

Example


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Bear Spread

Bearish on stock

Creating bear spread with puts

Buy a put with a high exercise price and sell a put

with a low exercise price

Example

Creating bear spread with calls

Buy a call with higher exercise price and sell a callwith a lower exercise price

Example


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Butterfly Spread

Involves two positions in options with three different

exercise prices

Buy a call with a relatively low exercise price, say E1

Buy a call with a relatively high exercise price, sayE3, and

Sell two calls with a strike price of E2

Usually, E2 is halfway between E1 and E3

E2 is usually close to the current stock price


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A butterfly spread leads to a profit if the stock price

stays close to E2, but

Gives a small loss if there is a significant movement

in either direction Good strategy if you feel significant stock price

changes are unlikely

Require small investment initially to setup the

spread


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Butterfly Spread


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Breakeven Point

Upper Breakeven Point = Strike Price of Higher

Strike Long Call - Net Premium Paid

Lower Breakeven Point = Strike Price of LowerStrike Long Call + Net Premium Paid


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Calendar Spread

Sell a call option with a certain exercise price

and

Buy a longer maturity call option with the

same strike price

Longer the maturity of the option bought, the

more expensive it is due to speculative value

of the option Requires initial investment to setup


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Assuming that the long-maturity option is sold

when the short-maturity option matures,

What will be the payoff diagram?

How to determine profit/loss?

Types of Calendar Spreads

Neutral Calendar Spreads

Bullish Calendar Spread Bearish Calendar Spread

Calendar Spread with Put Options


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Reverse Calendar Spread

If you anticipate the stock price to move into

in extremes, you can execute a reverse

calendar spread

Buy a call with a shorter maturity and

Sell a call with a longer maturity with the

same exercise price


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Combinations

Combination is an option trading strategy that

involves taking a position in both calls and

puts on the same stock

Straddle

Strips

Straps

Strangles Collars


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Straddle

Buy a call and buy a put with the same strike

price and expiration date

When do you profit?

When to use this strategy?

Breakeven points Upper Breakeven Point = Strike Price of Long Call + Net

Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net

Premium Paid


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Payoff diagram


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Short a straddle

Sale of a put and a call with the same

exercise price and expiration date

High risk strategy, especially if the stock price

moves too much


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Strips and Straps

Strip

Long position in one call and two puts with the

same strike price and expiration date


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Upper Breakeven Point = Strike Price of

Calls/Puts + Net Premium Paid

Lower Breakeven Point = Strike Price of

Calls/Puts - (Net Premium Paid/2)


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Strap

A long position in two calls and one put with the

same strike price and maturity

Upper Breakeven Point = Strike Price ofCalls/Puts + (Net Premium Paid/2)

Lower Breakeven Point = Strike Price of

Calls/Puts - Net Premium Paid


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Payoff diagram of a Strap


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Strangle

Buy a put and a call with the same maturity

date, but different strike prices


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Breakeven Point

Upper Breakeven Point = Strike Price of Long

Call + Net Premium Paid

Lower Breakeven Point = Strike Price of Long

Put - Net Premium Paid


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Collars

Buy a stock

Buy a put on the stock with an exercise price

lower than the current stock price

Sell a call on the stock with an exercise price

higher than the current stock price

Choose the call exercise price in such a

manner that the call premium completelyoffsets the put premium


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= Ns(STS) + NP[MAX(0, E1 - ST) P1] Nc[max(0, STE2) C2]

If stock price at maturity is below both theexercise prices?

If the stock price at maturity is between thetwo exercise prices

If the stock price at maturity is higher thanboth the exercise prices


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Payoff diagram of a Collar

4 4 Advanced Option Strategies

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