Trading Strategies With Options

8/8/2019 Trading Strategies With Options

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Options, Futures, and Other Derivatives 6th

Edition, Copyright John C. Hull 2005 10.1

Trading StrategiesInvolving Options

Chapter 10


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Types of Strategies

Covered Strategies: Take a position inthe option and the underlying

Spread Strategies: Take a position in 2or more options of the same type (Aspread)

Combination Strategies: Take a position

in a mixture of calls & puts (Acombination)


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Types of Strategies

These symbols imply the following:

NC or NP or NS > 0 implies buying (going long)

NC orNP orNS < 0 implies selling (going short)

The Profit Equations Profit equation for calls held to expiration

4 = NC[Max(0,ST - X) - C]

For buyer of one call (NC = 1) this implies

4 = Max(0,ST - X) - C For seller of one call (NC = -1) this implies

4 = -Max(0,ST - X) + C


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Types of Strategies

The Profit Equations (continued)

Profit equation for puts held to expiration

4 = NP[Max(0,X - ST) - P] For buyer of one put (NP = 1) this implies 4 = Max(0,X

- ST) - P

For seller of one put (NP = -1) this implies 4 = -Max(0,X - ST) + P


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Types of Strategies

The Profit Equations (continued)

Profit equation for stock

4 = NS[ST - S0] For buyer of one share (NS = 1) this implies 4 = ST - S0 For short seller of one share (NS = -1) this implies 4 = -ST

+ S0


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Positions in an Option & the

Underlying (Figure 10.1, page 224)

Profit

STK

Profit

ST

K

Profit

ST

K

Profit

ST

K

(a)(b)

(c) (d)


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Bull Spread Using Calls(Figure 10.2, page 225)

Bull Spread Using Calls: Buying a call option on a stock with aparticular strike price and selling a call option on the same stockwith a higher strike price.

Payoff from a Bull Spread:

Stock priceRange

Payoff fromLong CallOption

Payoff fromShort CallOption

Total Payoff

ST K2K1 < ST < K2ST K1

ST - K1ST - K10

K2 - ST0

0

K2 - K1ST K20


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Ex: An investor buys $3 a call with a strike price of $30 and sellsfor $1 a call with a strike price of $35.

Payoff from a Bull Spread:

Stock priceRange



Total Payoff

ST $35

$30 < ST < $35

ST $30

ST - $30 - $3

ST - $30 -$3

0 - $3

$35 - ST +$1

0+$1

0+$1

$3

ST - $32

-$2


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K1

K2

Profit

ST


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Bull Spread Using PutsFigure 10.3, page 226

K1

K2

Profit

ST


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Bear Spread Using CallsFigure 10.5, page 229

Bear Spread: Buying a call option on a stock with a particular strike priceand selling a call option on the same stock with a lower strike price.

Stock priceRange



Total Payoff

ST K2K1 < ST < K2ST K1

ST - K20

0

K1 - STK1 - ST0

-(K2 - K1)

-(ST K1)

0


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Example: An investor buys a call for $1 with a strike price of $35 and sellsfor $3 a call with a strike price of $30.

Stock priceRange



Total Payoff

ST $35

$30 < ST < $35

ST $30

ST - $35

0

0

$30 - ST$30 - ST0

-($35 - $30)

-(ST $30)

0


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K1

K2

Profit

ST


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Box Spread

A combination of a bull call spread and abear put spread

If all options are European a box spread isworth the present value of the differencebetween the strike prices

If they are American this is not necessarilyso. (See Business Snapshot 10.1)


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Butterfly Spread Using Calls

Butterfly Spread: buying a call option with a relative lowstrike price, K1,, buying a call option with a relative highstrike price. K3, and selling two call options with a strikeprice halfway in between, K2.

Stock priceRange

Payofffrom FirstLong CallOption

Payoff fromSecondLong CallOption

Payoff fromShort Calls

Total Payoff

ST

K3

K2 < ST < K3K2 < ST < K3ST K1

ST

- K1ST - K1

ST - K10

ST

- K30

0

0

-2(ST

- K2)

-2(ST - K2)

0

0

0

K3 - STST - K10


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Butterfly Spread Using Calls

Example: Call option prices on a $61 stock are: $10 for a $55 strike, $7for a $60 strike, and $5 for a $65 strike. The investor could create abutterfly spread by buying one call with $55 strike price, buying a call witha $65 strike price, and selling two calls with a $60 strike price.

Stock priceRange

Payofffrom FirstLong CallOption

Payoff fromSecondLong CallOption

Payoff fromShort Calls

Total Payoff

ST

$65

$60 < ST


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Butterfly Spread Using CallsFigure 10.6, page 231

K1

K3

Profit

ST

K2


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Calendar Spread Using CallsFigure 10.8, page 232

Profit

ST

K


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Options, Futures, and Other Derivatives 6

th


Calendar Spread Using PutsFigure 10.9, page 233

Profit

ST

K


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Options, Futures, and Other Derivatives 6

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A Straddle CombinationFigure 10.10, page 234

Straddle:Buying a call and a put with the same strike price and expirationDate.

Stock priceRange

Payoff from Call Payoff from Put Total Payoff

ST K

ST < K

ST K

0

0

K - ST

ST - K

K - ST


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Options, Futures, and Other Derivatives6

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A Straddle CombinationFigure 10.10, page 234

Profit

ST

K


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Options, Futures, and Other Derivatives 6th Edition, Copyright John C. Hull 200510.26

Strip & Strap

Strip: combining one long call with two long putsStrap: combining two long calls with one long put

Profit

K ST

Profit

K ST

Strip Strap


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Options, Futures, and Other Derivatives 6th Edition, Copyright John C. Hull 200510.27

A Strangle Combinationbuying one call with a strike price of K2 and buying one put with a

strike price of K1

K1

K2

Profit

ST

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Trading Strategies With Options