Proven Options Strategies

8/8/2019 Proven Options Strategies

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25PROVEN STRATEGIESor trading options on CME Group utures





A wORld O OPTIONS ONA SINGlE POwER ul PlAT ORm.

With more than 2.2 billion contracts (valued at$1.1 quadrillion) traded in 2007, CME Group is theworld’s largest and most diverse derivatives exchange.

Building on the heritage o CME, CBOT and NYMEX,CME Group serves the risk management needs ocustomers around the globe. As an internationalmarketplace, CME Group brings buyers and sellerstogether on the CME Globex electronic trading

plat orm and on trading oors in Chicago and NewYork. CME Group o ers the widest range o benchmarkproducts available across all major asset classes,including utures and options based on interest rates,equity indexes, oreign exchange, energy, agricultural

commodities, metals, and alternative investmentproducts such as weather and real estate. Options on utures rank among our most versatilerisk management tools, and we o er them on mosto our products. Whether you trade options orpurposes o hedging or speculating, you can limit yourrisk to the amount you paid up- ront or the optionwhile maintaining your exposure to bene cial pricemovements.

CME Group is the trademark o CME Group, Inc. The Globe logo, Globex ® and CME ® aretrademarks o Chicago Mercantile Exchange, Inc. CBOT ® is the trademark o the Boardo Trade o the City o Chicago. NYMEX, New York Mercantile Exchange, and ClearPortare trademarks o New York Mercantile Exchange. Inc. COMEX is a trademark oCommodity Exchange, Inc. Copyright © 2008 CME Group. All rights reserved



HOw TO uSE THIS BOOKlET

Each illustration demonstrates the e ect o time decay on thetotal option premium involved in the position. The le t verticalaxis shows the pro t/loss scale. The horizontal zero line in themiddle is the break-even point, not including commissions.There ore, anything above that line indicates pro ts, anythingbelow it, losses. The price o the underlying instrument isrepresented along the bottom. “A,” “B” and “C” in the diagramsindicate the strike prices. The arrows show the impact o timedecay on an option.

Arrows on the diagram under the heading o “Pattern Evolution”

indicate what impact the decay o option prices with time hason the total position. The purple line refects the situation withour months le t until expiration, the gold line the status with one

month le t and the green line the situation at expiration.

Pattern evo tion:

or ore in or ation,go to .c egro p.co /options .



TABlE O CONTENTSLong Futures 1Short Futures 2Long Synthetic Futures 3Short Synthetic Futures 4Long Risk Reversal 5(AKA Squash or Combos)Short Risk Reversal 6(AKA Squash or Combos)Long Call 7

Short Call 8Long Put 9Short Put 10Bull Spread 11Bear Spread 12Long Butter y 13Short Butter y 14Long Iron Butter y 15Short Iron Butter y 16Long Straddle 17Short Straddle 18Long Strangle 19Short Strangle 20Ratio Call Spread 21Ratio Put Spread 22Call Ratio Backspread 23Put Ratio Backspread 24

Box or Conversion 25



1lONG uTuRES

CATEGORY: DirectionalSYNTHETICS: Long call A, short put A

A

when to se: When you are bullish on the market anduncertain about volatility. You will not be a ected by volatility changing. However, i you have an opinion on volatility and thatopinion turns out to be correct, one o the other strategies may have greater pro t potential and/or less risk.

Proft characteristics: Pro t increases as market rises. Pro tis based strictly on the di erence between the exit price and theentry price.

loss characteristics: Loss increases as market alls. Loss isbased strictly on the di erence between the exit price and theentry price.

decay characteristics: None.

Pattern evo tion:



2SHORT uTuRES

CATEGORY: DirectionalSYNTHETICS: Long put A, short call A

A

when to se: When you are bearish on the market anduncertain about volatility. You will not be a ected by volatility changing. However, i you have an opinion on volatility and thatopinion turns out to be correct, one o the other strategies may have greater pro t potential and/or less risk.

Proft characteristics: Pro t increases as market alls. Pro t isbased strictly on the di erence between the entry price and theexit price.

loss characteristics: Loss increases as market rises. Loss isbased strictly on the di erence between the entry price and the

exit price.decay characteristics: None.

Pattern evo tion:



3lONG SYNTHETIC

uTuRES

CATEGORY: DirectionalLong call A, short put A

when to se: When you are bullish on the market anduncertain about volatility. You will not be a ected by volatility changing. However, i you have an opinion on volatility and thatopinion turns out to be correct, one o the other strategies may have greater pro t potential and/or less risk. May be traded into

rom initial long call or short put position to create a strongerbullish position.

Proft characteristics: Pro t increases as market rises. Pro tis based strictly on the di erence between the exit price and thesynthetic entry price.

loss characteristics: Loss increases as market alls. Loss isbased strictly on the di erence between the exit price and the

synthetic entry price.


Pattern evo tion:

A



4SHORT SYNTHETIC

uTuRES

when to se: When you are bearish on the market anduncertain about volatility. You will not be a ected by volatility changing. However, i you have an opinion on volatility and thatopinion turns out to be correct, one o the other strategies may have greater pro t potential and/or less risk. May be traded into

rom initial short call or long put position to create a strongerbearish position.

Proft characteristics: Pro t increases as market alls. Pro tis based strictly on the di erence between the synthetic entry priceand the exit price.

loss characteristics: Loss increases as market rises. Loss isbased strictly on the di erence between the synthetic entry price

and the exit price.


Pattern evo tion:

A

CATEGORY: DirectionalLong put A, short call A



lONG RISK REVERSAl(AKA SQuASHOR COmBOS)

(SPlIT STRIKE)

5

CATEGORY: DirectionalLong call B, short put A

A B

when to se: When you are bullish on the market anduncertain about volatility. Normally this position is initiated asa ollow-up to another strategy. Its risk/reward is the same as a LONG FUTURES except that there is a fat area o little or nogain/loss.

Proft characteristics: Pro t increases as market rises abovethe long call strike price. Pro t at expiration is open-ended andis based on the exercise price o B +/– price received or paid toinitiate position.

loss characteristics: Loss increases as market alls below the short put. Loss at expiration is open-ended and is based on

the exercise price o A +/– premium received or paid to initiateposition.

decay characteristics: Time decay characteristics vary according to the relationship o the call strike price, put strikeprice and the underlying utures price at the time the positionis established. The position is time decay neutral (not a ected)

i the utures price is exactly mid-way between the call and putstrike prices; long time decay (bene ts rom time decay) when theutures price is closer to the call than the put strike price and short

time decay (time decay erodes the value o the position) when theutures price is closer to the put than the call strike price.

Pattern evo tion:



6SHORT RISK REVERSAl(AKA SQuASHOR COmBOS)(SPlIT STRIKE)

CATEGORY: DirectionalLong put A, short call B

A B

Pattern evo tion:

when to se: When you are bearish on the market anduncertain about volatility. Normally this position is initiated asa ollow-up to another strategy. Its risk/reward is the same as a SHORT FUTURES except that there is a fat area o little or nogain/loss.

Proft characteristics: Pro t increases as market alls below the long put strike price. Pro t at expiration open-ended and is

based on the exercise price o A +/– premium received or paid toinitiate position.

loss characteristics: Loss increases as market rises abovethe short call. Loss at expiration is open-ended and is based on

the exercise price o B +/– premium received or paid to initiateposition.

decay characteristics: Time decay characteristics vary according to the relationship o the call strike price, put strikeprice and the underlying utures price at the time the positionis established. The position is time decay neutral (not a ected)i the utures price is exactly mid-way between the call and putstrike prices; long time decay (bene ts rom time decay) when the

utures price is closer to the put than the call strike price and shorttime decay (time decay erodes the value o the position) when the

utures price is closer to the call than the put strike price.



7lONG CAll

CATEGORY: DirectionalSYNTHETICS: Long instrument, long put

A

when to se: When you are bullish to very bullish on themarket. In general, the more out-o -the-money (higher strike)calls, the more bullish the strategy.

Proft characteristics: Pro t increases as market rises. At

expiration, break-even point will be call option exercise price A +price paid or call option.

loss characteristics: Loss limited to amount paid or option.Maximum loss realized i market ends below option exercise A.

decay characteristics: Position is a wasting asset. As timepasses, value o position erodes toward expiration value.

Pattern evo tion:





9lONG PuT

CATEGORY: DirectionalSYNTHETICS: Short instrument, long call

A

when to se: When you are bearish to very bearish on themarket. In general, the more out-o -the-money (lower strike) theput option strike price, the more bearish the strategy.

Proft characteristics: Pro t increases as markets alls. At

expiration, break-even point will be option exercise price A –price paid or option. For each point below break-even, pro tincreases by additional point.

loss characteristics: Loss limited to amount paid or option.Maximum loss realized i market ends above option exercise A.

decay characteristics: Position is a wasting asset. As timepasses, value o position erodes toward expiration value.

Pattern evo tion:



10SHORT PuT

CATEGORY: DirectionalSYNTHETICS: Long instrument, short call

A

when to se: I you rmly believe the market is not goingdown. Sell out-o -the-money (lower strike) options i you are only somewhat convinced: sell at-the-money options i you are very con dent the market will stagnate or rise. I you doubt market will stagnate and are more bullish, sell in-the-money options ormaximum pro t.

Proft characteristics: Pro t limited to premium receivedrom put option sale. At expiration, break-even point is exercise

price A – premium received. Maximum pro t realized i marketsettles at or above A.

loss characteristics: Loss potential is open-ended. Lossincreases as market alls. At expiration, losses increase by one

point or each point market is below breakeven. Because risk isopen-ended, position must be watched closely.

decay characteristics: Position bene ts rom time decay.The option seller’s pro t increases as option loses its time value.Maximum pro t rom time decay occurs i option is at-the-money.

Pattern evo tion:



11Bull SPREAd

CATEGORY: DirectionalLong call A, short call BLong put A, short put B

when to se: I you think the market will go up, but withlimited upside. Good position i you want to be in the marketbut are less con dent o bullish expectations. You’re in goodcompany. This is the most popular bullish trade.

Proft characteristics: Pro t limited, reaching maximum i market ends at or above strike price B at expiration. I call-vs.-call version (most common) used, break-even is at A + net costo spread. I put-vs.-put version used, break-even is at B – netpremium collected.

loss characteristics: What is gained by limiting pro t

potential is mainly a limit to loss i you guessed wrong onmarket. Maximum loss i market at expiration is at or below A.With call-vs.-call version, maximum loss is net cost o spread.

decay characteristics: I market is midway between A andB, little i any time decay e ect. I market is closer to B, timedecay is generally a bene t. I market is closer to A, time decay isgenerally detrimental to pro tability.

Pattern evo tion:

A

B



12BEAR SPREAd

CATEGORY: DirectionalShort put A, long put BShort call A, long call B

when to se: I you think the market will go down, but with limited downside. Good position i you want to be in themarket but are less con dent o bearish expectations. The mostpopular position among bears because it may be entered as a conservative trade when uncertain about bearish stance.

Proft characteristics: Pro t limited, reaching maximumat expiration i market is at or below strike price A. I put-vs.-put version (most common) used, break-even is at B – net cost o spread. I call-vs.-call version, break-even is at A + net premiumcollected.

loss characteristics: By accepting a limit on pro ts, youalso achieve a limit on losses. Losses, at expiration, increase as

market rises to B, where they are at a maximum. With put-vs.-put version, maximum loss is net cost o spread.

decay characteristics: I market is midway between A andB, little i any time decay e ect. I market is closer to A, timedecay is generally a bene t. I market is closer to B, time decay isgenerally detrimental to pro tability.

Pattern evo tion:

A

B



13lONG

BuTTER lY

CATEGORY: PrecisionLong call A, short 2 calls B, long call CLong put A, short 2 puts B, long put C(Note: B – A generally is equal to C – B)

when to se: One of the few positions which may be enteredadvantageously in a long-term options series. Enter when, withone month or more to go, cost of the spread is 10 percent or lessof B – A (20 percent if a strike exists between A and B). This is a rule of thumb; check theoretical values.

Proft characteristics: Maximum pro t occurs i a market isat B at expiration. That pro t would be B – A – net cost o spread.This pro t develops, almost totally, in the last month.

loss characteristics: Maximum loss, in either direction, iscost o spread. A very conservative trade, break-evens are at A +

cost o spread and at C – cost o spread.decay characteristics: Decay negligible until nal month,during which distinctive pattern o butterfy orms. Maximumpro t growth is at B. I you are away rom (A-C) range enteringthe last month, you may wish to liquidate position.

Pattern evo tion:

A C

B



14SHORTBuTTER lY

CATEGORY: PrecisionShort call A, long 2 calls B, short call CShort put A, long 2 puts B, short put C(Note: B – A generally is equal to C – B)

when to se: When the market is either below A or aboveC and position is overpriced with a month or so le t. Or whenonly a ew weeks are le t, market is near B, and you expect animminent move in either direction.

Proft characteristics: Maximum pro t equals the credit at which spread is established. Occurs when market, at expiration,is below A or above C, thus making all options in-the-money or alloptions out-o -the-money.

loss characteristics: Maximum loss occurs i market is at Bat expiration. Amount o that loss is B – A – credit received when

setting up position. Break-evens are at A + initial credit and C –initial credit.

decay characteristics: Decay negligible until nal month,during which distinctive pattern o butterfy orms. Maximum lossacceleration is at B.

Pattern evo tion:

A C

B



15lONG IRONBuTTER lY

CATEGORY: PrecisionShort 1 call and 1 put at B, buy 1 put at A, buy 1 call at Cor sell straddle at strike price A and buy strangle at AC

or protection(Note: B – A generally is equal to C – B)

when to se: One o the ew positions which may be enteredadvantageously in a long-term options series. Enter when, withone month or more to go, cost o the spread is 10 percent or lesso B – A (20 percent i a strike exists between A and B). This is a rule o thumb; check theoretical values.

Proft characteristics: Maximum pro t occurs i a marketis at B at expiration. Pro t would be equal to short straddlepremium minus long strangle premium. This pro t develops,almost totally, in the last month.

loss characteristics: Maximum loss, in either direction,

net premium collected minus (B-A). This is a very conservativetrade, break-evens are at B + and – net premium collected.

decay characteristics: Decay negligible until nal month,during which distinctive pattern o butterfy orms. Maximumpro t growth is at B. I you are away rom (A-C) range enteringthe last month, you may wish to liquidate position.

Pattern evo tion:

A C

B



16SHORT IRONBuTTER lY

CATEGORY: PrecisionLong straddle B, short strangle at AC

Short put A, long put B, long call B, short call C(Note: B – A generally is equal to C – B)

when to se: When the market is either below A or aboveC and position is overpriced with a month or so le t. Or whenonly a ew weeks are le t, market is near B, and you expect animminent breakout move in either direction.

Proft characteristics: Maximum pro t equals (B – A) lessthe net debit to create the position. Occurs when market, atexpiration, is below A or above C.

loss characteristics: Maximum loss occurs i market is atB at expiration. Amount o that loss is net debit to create theposition. Break-evens are at B + and – initial debit.

decay characteristics: Decay negligible until nal month,during which distinctive pattern o butterfy orms. Maximumpro t growth is at B. I you are away rom (A-C) range enteringlast month, you may wish to liquidate position.

Pattern evo tion:

A C

B



17lONG

STRAddlE

CATEGORY: PrecisionLong call A, long put ASYNTHETICS: Long 2 calls A, short instrumentLong 2 puts A, long instrument(All done to initial delta neutrality. A delta neutral spreadis a spread established as a neutral position by usingthe deltas o the options involved. The neutral ratio isdetermined by dividing the delta o the purchased optionby the delta o the written option)

when to se: I market is near A and you expect it to startmoving but are not sure which way. Especially good position i market has been quiet, then starts to zigzag sharply, signalingpotential eruption.

Proft characteristics: Pro t open-ended in either direction. At expiration, break-even is at A, +/– cost o spread. However,

position is seldom held to expiration because o increasing timedecay with passage o time.

loss characteristics: Loss limited to the cost o spread.Maximum loss occurs i market is at A at expiration.

decay characteristics: Time decay accelerates as optionsapproach expiration. Position is generally liquidated well be oreexpiration.

Pattern evo tion:

A



18SHORTSTRAddlE

CATEGORY: PrecisionShort call A, short put ASYNTHETICS: Short 2 calls A, long instrumentShort 2 puts A, short instrument(All done to initial delta neutrality)

when to se: I market is near A and you expect market isstagnating. Because you are short options, you reap pro ts as they decay – as long as market remains near A.

Proft characteristics: Pro t maximized i market, at

expiration, is at A. In call-put scenario (most common),maximum pro t is equal to the credit rom establishing position;break-even is A +/– total credit.

loss characteristics: Loss potential open-ended in eitherdirection. Position, there ore, must be closely monitored andreadjusted to delta neutral i market begins to dri t away rom A.

decay characteristics: Because you are only short options, you pick up time-value decay at an increasing rate as expirationapproaches. Time decay is maximized i market is near A.

Pattern evo tion:

A



19lONG

STRANGlE

CATEGORY: PrecisionLong put A, long call B

(Generally done to initial delta neutrality)

when to se: I market is within or near (A-B) range and hasbeen stagnant. I market explodes either way, you make money;i market continues to stagnate, you lose less than with a longstraddle. Also use ul i implied volatility is expected to increase.

Proft characteristics: Pro t open-ended in either direction.Break-even levels are at A – cost o spread and B + cost o spread.However, spread is usually not held to expiration.

loss characteristics: Loss limited. Loss is equal to net costo position. Maximum loss occurs i , at expiration, market isbetween A and B.

decay characteristics: Decay accelerates as options approachexpiration but not as rapidly as with long straddle. To avoidlargest part o decay, the position is normally liquidated prior toexpiration.

Pattern evo tion:

A B





21RATIO CAll

SPREAd

CATEGORY: PrecisionLong call A, short calls BFor example long 1 call @ A; short 2 calls @ B

when to se: Usually entered when market is near A and userexpects a slight to moderate rise in market but sees a potential

or sell-o . One o the most common option spreads, seldomdone more than 1:3 (two excess shorts) because o upside risk.

Proft characteristics: Maximum pro t, is equal to B – A –net cost o position ( or call-vs.-call version), realized i market isat B at expiration or B – A + net credit o position (i long optionpremium is less than premium collected rom the sale o two ormore options).

loss characteristics: Loss limited on downside (to net cost

of position in call-vs.-call, or no loss if position established at a credit) but open-ended if market rises. Rate of loss, if marketrises beyond strike price B, is proportional to number of excessshorts in position.

decay characteristics: Depends on the net time valuepurchased or sold via this strategy. I more time value sold thanbought, then time value decays works to the bene t o theholder o this strategy.

Pattern evo tion:

A

B



22RATIO PuTSPREAd

CATEGORY: PrecisionLong put B, short puts AFor example long 1 put @ B; short 2 puts @ A

when to se: Usually entered when market is near B and youexpect market to all slightly to moderately, but see a potential

or sharp rise. One o the most common option spreads, seldomdone more than 1:3 (two excess shorts) because o downside risk.

Proft characteristics: Maximum pro t in amount o B – A –net cost o position ( or put-vs.-put version), realized i marketis at A at expiration, or B – A + net credit o position (i longoption premium is less than premium collected rom the sale o two or more options).

loss characteristics: Loss limited on upside (to net cost of

position in put-vs.-put version, or no loss if position establishedat a credit) but open-ended if market falls. Rate of loss, if marketfalls below strike price A, is proportional to number of excessshorts in position.

decay characteristics: Dependent on the net time valuepurchased or sold via this strategy. I more time value sold thanbought, then time value decays works to the bene t o the holder.

Pattern evo tion:

A

B



23CAll RATIO

BACKSPREAd

CATEGORY: PrecisionShort call A, long 2 or more calls B

when to se: Normally entered when market is near B andshows signs o increasing activity, with greater probability toupside.

Proft characteristics: Pro t limited on downside (i net

credit taken in when position was established) but open ended inrallying market.

loss characteristics: Maximum loss, is amount o B – A –initial credit (or B – A + initial debit), is realized i market is atB at expiration. This loss is less than or equivalent long straddle,the trade-o or sacri cing pro t potential on the downside.

decay characteristics: Dependent on the net time valuepurchased or sold via this strategy. I more time value sold thanbought, then time value decays works to the bene t o the holder.

Pattern evo tion:

A

B



24PuT RATIOBACKSPREAd

CATEGORY: PrecisionShort 1 put B, long 2 or more puts A

when to se: Normally entered when market is near A andshows signs o increasing activity, with greater probability todownside ( or example, i last major move was up, ollowed by stagnation).

Proft characteristics: Pro t limited on upside (to net credittaken in when position was established) but open ended incollapsing market.

loss characteristics: Maximum loss, is amount o B – A –initial credit (or B – A + initial debit), realized i market is at A atexpiration. This loss is less than or the equivalent long straddle,

the trade-o or sacri cing pro t potential on the upside.decay characteristics: Dependent on the net time valuepurchased or sold via this strategy. I more time value sold thanbought, then time value decays works to the bene t o the holder.

Pattern evo tion:

A

B



25BOX OR

CONVERSION

CATEGORY: Locked or arbitrage trade.These spreads are re erred to as “locked trades”because their value at expiration is totally independento the price o the underlying instrument. I you can buythem or less than that value or sell them or more, youwill make a pro t (ignoring commission costs).

when to se: Occasionally, a market will get out o line enoughto justi y an initial entry into one o these positions. However,they are most commonly used to “lock” all or part o a port olio by buying or selling to create the missing “legs” o the position. Theseare alternatives to closing out positions at possibly un avorableprices.

long box: Long a bull spread, long a bear spread — that is, longcall A, short call B, long put B, short put A. Value = B – A – NetDebit.

Short box: Long call B, short call A, long put A, short put B.

Value = Net Credit + (A – B).long-instr ent conversion: Long instrument, long put A,short call A. Value = 0. “Price” = instrument + put – A – call.

Short-instr ent conversion: Short instrument, long call A, short put A. Value = 0. “Price” = A + call – instrument – put.

A B

Pattern evo tion:





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Proven Options Strategies