Trading Strategies Involving Options Chapter 10
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Trading StrategiesInvolving Options
Chapter 10
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Positions in an Option & the Underlying
• Buy or sell call
• Buy or sell put
• buy or short sell stock
• buy (lend at) or sell (borrow at) risk-free bond (rate)
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Trading Strategies Involving Options
• Take a position in the option & the underlying
• Spread: Position in 2 or more options of the same type
• Combination: Position in a mixture of calls & puts
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Payoff for Put Option
X
x
buy
sell
ST
-X
Cost = p
Cost = -p
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Payoff for Call Option
X
x
buy
sell
ST
Cost = c
Cost = -c
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Payoff for Stock
buy
ST
sell
Cost = S
Cost = -S
7Payoff for Investing or Borrowing PV(X) in
Risk-Free Bond
buy
sell
ST
X
-X
Cost = Xe-rT
Cost = -Xe-rT
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Method
• Draw payoff pattern for each position
• Add patterns together to obtain payout pattern
• Determine cost of portfolio
• Subtract cost of portfolio to obtain profit pattern
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Write a Covered Call
X
sellcall
ST
buy stock
X Cost = S - c
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Profit Pattern for Covered Call
X ST
X Cost = S - c
X-S+c
X-S+c-S+c
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Payoff for Protective Put
X
x
ST
Cost = S + p
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Profit Pattern Protective Put
x
ST
Cost = S + p
X-S-p
S+p
X
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Bull Spread
• Buy 1 call and sell 1 call at higher strike
buy
sell
STX1
Cost = c1 - c2 > 0
X2-X1
X2
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Profit Pattern for Bull Spread
ST
X2-X1 -c1+c2
-c1+c2
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Bear Spread
• Sell 1 call and buy 1 call at higher strike
buy
sell
STX1
Cost = c1 - c2 < 0
X2-X1
X2
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Profit Pattern for Bear Spread
STX1
Cost = c1 - c2 < 0
X2
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Buy a Straddle
• Buy 1 call and 1 put at same strike
X
Cost = c + pX
-p-c
X-p-c X+p+c
profit
payout
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Butterfly Spread• Buy 1 call at X1, sell 2 calls at X2, buy 1 call
at X3
m = +1
m = - 2
m = -1
Cost = c1 - 2c2 + c3
X1
X2
X3
m = 0
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Butterfly Spread• Buy 1 call, sell 2 calls, buy 1 call
Cost = c1 - 2c2 + c3
X2-X1 payoff
profitcost
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Bull Spread Using Calls• Figure 10.2
X1 X2
Profit
ST
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Bull Spread Using Puts• Figure 10.3
X1 X2
Profit
ST
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Bear Spread Using Calls• Figure 10.4
X1 X2
Profit
ST
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Bear Spread Using Puts• Figure 10.5
X1 X2
Profit
ST
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Butterfly Spread Using Calls• Figure 10.6
X1 X3
Profit
STX2
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Butterfly Spread Using Puts• Figure 10.7
X1 X3
Profit
STX2
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A Straddle Combination• Figure 10.10
Profit
STX
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Strip & Strap• Figure 10.11
Profit
X ST
Profit
X ST
Strip Strap
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A Strangle Combination• Figure 10.12
X1 X2
Profit
ST
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Summary• Write covered call: buy stock sell call
• Protective put: buy stock and buy put
• Bull spread: buy X1 call and sell X2 call
• Bear spread: opposite of bull
• Buy Straddle: buy X call and buy X put
• Sell Straddle: opposite of buy straddle
• Strangle: buy X1 put and buy X2 call
• Butterfly spread: buy 1 X1 call, sell 2 X2 calls, and buy 1 X3 call
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