7/30/2019 Option Strategies Corporate
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Options Strategies
By Vaibhav KabraM.F.S.M, F.R.M.
7/30/2019 Option Strategies Corporate
2/23
Options & Strategies
1
Option:
An option is an agreement between two parties for a specified time period (up to the expiry date) that gives the holder the right, not theobligation, to buy or sell a specified number of shares, usually a lot of 100, at a pre-determined price (exercise or strike price). You can
buy and sell options just like shares.
When the option is acquired, the buyer of the option (holder) pays a premium (price of the option) to the seller (writer). The holder thus
obtains the right to decide what happens. The writer must abide by the decision of the holder. It is important to understand that an
option contract is simply a right on the part of the buyer and an obligation on the part of the writer to transact at a future date.
Types: There are two types of options, options to buy (call options) and options to sell (put options).
Strike price: The strike price is the price at which the option holder can buy (or sell) the shares. If you hold a call option on ABC Inc.
at a strike price of $50.00, you can exercise the option and pay only $50.00 per share even if the stock is trading at a higher price.
Premium: The premium is the price of the option, i.e. the amount the buyer pays to the seller for the right of the option. The premium
is not a down payment on a future stock purchase. The seller keeps the premium even if the option is not exercised. The option holder
pays a premium and hopes to make a profit by reselling the option or exercising it. The option writer, on the other hand, considers the
premium he receives from the buyer as a source of additional income or as protection. He receives the premium as compensation for the
risks he assumes in agreeing to honour the option terms.
Intrinsic value of options: The intrinsic value of a call option is the difference between the price of the underlying stock and the option
strike price. A positive intrinsic value means that the option is currently in-the-money. An intrinsic value of or near zero means that the
option is at-the-money. By definition, the intrinsic value cannot be negative. A negative intrinsic value (we say that it has no value)
means that the option is out-of-the-money.
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Time value of options: The time value of an option is the portion of the option premium that is attributable to the amount of time
remaining until the expiration of the option contract. Time value is the difference between the option premium and its intrinsic value.
The factors that strongly impact the time value are the volatility of the underlying stock, the remaining time to expiry, the dividends
paid out during the life of the option, the risk-free interest rates, and the supply and demand for the option (implied volatility).
Components that influence option premiums:
Market dynamics influence option premiums in different ways. It is essential to understand these dynamics in order to evaluate the
impact of variations of certain components on the value of options. Following are the six components that affect the value of options.
Underlying stock price: The market price of the stock underlying a particular option is the most important determinant ofoption premiums because if the stock price is much higher or much lower than the strike price, the effect of other components will be
very small. In general, the relationship of a call option premium to the price of the underlying stock is quite simple. If the price of the
stock rises, the call option premium will tend to rise, all else being equal. Conversely, the premium of a put option tends to rise as the
value of the underlying share declines. The higher the stock price, the greater the value of a call option and the lower the value of a put
option.
Strike price: In the case of call options, the higher the strike price compared to the stock price, the lower the value of the option. In the
case of put options, the higher the strike price compared to the stock price, the greater the value of the option.
Time to expiry: Generally, the more time remaining before an option expires, the higher the premium. It is quite logical when we recall
that option writers demand larger premiums when they perceive their risks to be greater. For example, the premium for a December
option contract on a particular stock is higher than the premium for a September contract on the same stock because the December
option gives three additional months during which the price of the stock can go up or down.
Options & Strategies
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Stock price volatility: The more volatile the price of the underlying stock, the higher the price of both the call and the put
options. Why? Because the greater the volatility, the greater the fluctuation in the stock price, hence the greater the likelihood that each
option will be deeply in-the-money on the expiry date. Similarly, stock option premiums in general will rise if overall stock market
conditions are more volatile.
Risk-free interest rates: Interest rates during the life of an option have the opposite effect on the price of call and put options. High
interest rates tend to drive up the premium of call options (all else being equal) and drive down the premium of put options. However,
studies have shown that changes in interest rates have little effect on the options price. When interest rates are high, investors prefer to
buy call options rather than the actual shares (because less investment is required) and invest the rest of their money in fixed income
instruments offering a higher return. This significant advantage of call options during periods of high interest rates will result in higher
call option premiums, as the call options become more attractive to investors. The cost of carry of an equivalent stock position at
short-term rates will, therefore, be built into the premium.
Anticipated dividends during the life of the option: Since the stock price will generally decrease by the amount of the dividend (after
the ex-dividend date), the call option on the stock will necessarily be worth less. Therefore, imminent dividend payments are reflected
in lower call option premiums. Conversely, since the price of the underlying stock will
generally decrease by the amount of the dividend, and put premiums rise as the stock price falls, the put premium will reflect the
anticipated drop in the stock price.
Options & Strategies
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Sr. No Strategies Objectives
1 Long Call Understanding Option Strategies
2 Short Call How it is used / Implementation
3 Long Putt When it is used / Outlook
4 Short Putt Understanding PayOff Diagrams
5 Covered Call
6 Protective Putt
7 Bull Spread
8 Bear Spread
9 Long Straddle
10 Short Straddle
11 Long Strangle
12 Short Strangle
13 Long Strip14 Short Strip
15 Long Strap
16 Short Strap
17 Long Butterfly
18 Short Butterfly
Strategies
Options & Strategies
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Mkt Price Premium Call Putt Profit / Loss
90 -10 - - -10100 -10 - - -10
105 -10 100 - -5
110 -10 100 - 0
130 -10 100 - 20
150 -10 100 - 40
Strike Price 100Premium 10
Long Call: A Bullish Strategy wherein an option to Buy' (Call)
is 'Purchased' presuming that the price of the underlying is going
to increase in the future & hence to hedge against such rise in
price this option is bought to buy the underlying at the predecided price StrikePrice on a certain Future Date.
Important Points:
Outlook: Bullish
Max Profit: Unlimited
Max Loss: Limited to premium paid
Motivation: Expectation is that the price of the underlying is
going to rise in the future, so to hedge against it, the price is
fixed at a particular strike price at which it would be purchased
at a future date.
Example:
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-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call
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Short Call: A Bearish Strategy wherein an option to 'Buy (Call)
is 'Sold' presuming that the price of the underlying is not going to
increase or will decrease in the future. Here as the outlook is
bearish the option to buy "Call" is sold thinking that it would notbe exercised & premium can be earned in return.
Important Points:
Outlook: Bearish
Max Profit: Premium Received
Max Loss: Unlimited
Motivation: Expectation is that the price of the underlying is
going to fall in the future, so a Call is sold at a Strike Price above
which the price of the underlying is not expected to go & hence
earning a premium.
Mkt Price Premium Call Putt Profit / Loss
90 10 - - 10100 10 - - 10
105 10 100 - 5
110 10 100 - 0
130 10 100 - -20
150 10 100 - -40
Strike Price 100Premium 10
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call
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Long Putt: A Bearish Strategy wherein an option to 'Sell' is
'Purchased' presuming that the price of the underlying is going to
decrease in the future. Hence to hedge against the risk of fall in
price this option is bought to sell the underlying at a the predecided price StrikePrice on a certain Future Date.
Important Points:
Outlook: Bearish
Max Profit: Limited & Maximum when Mkt Price = 0.
Max Loss: Limited to premium paid.
Motivation: Expectation is that the price of the underlying is
going to fall in the future, so to hedge against it, the price is fixed
at a particular strike price at which it would be sold at a future
date irrespective of its Mkt Price.
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Mkt Price Premium Call Putt Profit / Loss
70 -10 - 100 2090 -10 - 100 0
95 -10 - 100 -5
100 -10 - - -10
110 -10 - - -10
130 -10 - - -10
Strike Price 100Premium 10
Long Putt
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Short Putt: A Bullish Strategy wherein an option to 'Sell' is
'Sold' presuming that the price of the underlying is not going to
decrease or will increase in the future. Here as the outlook is
bullish the option to sell "Putt" is sold thinking that it would notbe exercised & premium can be earned in return.
Important Points:
Outlook: Bullish
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0.
Motivation: Expectation is that the price of the underlying is
going to rise in the future, so a Putt is sold at a strike price below
which the price of the underlying is not expected to go & hence
earning a premium.
Mkt Price Premium Call Putt Profit / Loss
70 10 - 100 -2090 10 - 100 0
95 10 - 100 5
100 10 - - 10
110 10 - - 10
130 10 - - 10
Strike Price 100Premium 10
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Putt
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Covered Call: A strategy in which you possess the stock & dont
want to sell it in short term. So, you sell the option to buy on the
same stock (Short Call) assuming that price of the underlying is
not going to rise in short term & hence to benefit from thepremium received.
Important Points:
Outlook: Bearish
Max Profit: Limited to the premium received.
Max Loss: Unlimited
Motivation: Expectation is that the price of the underlying is not
going to rise in the future, so a Call is sold at a strike price above
which the price of the underlying is not expected to go & hence
earning a premium.
Mkt Price Premium Call Putt Profit / Loss
90 -10 - - 10100 -10 - - 10
105 -10 100 - 5
110 -10 100 - 0
130 -10 100 - -20
150 -10 100 - -40
Strike Price 100Premium 10
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Stock
Call
Profit/Loss
Covered Call
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Protective Putt: A strategy in which you possess the stock &
think that its price will rise in the long term but want to hedge
against the fall in the price of the same, so you buy the option to
sell ( Long Putt)
Important Points:
Outlook: Bearish
Max Profit: Limited & Maximum when Mkt Price = 0.Max Loss: Limited to premium paid.
Motivation: Expectation is that the price of the underlying is
going to rise in the future, but as the underlying is possessed
physically, investor wants to hedge against the fall in prices &
hence a Putt option is bought.
Mkt Price Premium Call Putt Profit / Loss
70 -10 - 100 2090 -10 - 100 0
95 -10 - 100 -5
100 -10 - - -10
110 -10 - - -10
130 -10 - - -10
Strike Price 100Premium 10
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Stock
Put
Profit/Loss
Protective Putt
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Bull Spread: A strategy in which Option to buy is bought
(Long Call) & sold (Short Call) but at a diff. strike price.
Investor thinks that market will not fall but wants to limit his
risk by getting the premium on Call sold.
Important Points:
Outlook: Bullish
Max Profit: At Higher Strike Price.
Max Loss: Limited to the difference in premium.
Motivation: Expectation is that the price of the underlying is
going to rise in the future, so a Call is purchased. Investor also
wants to cover the premium loss on Long Call, so he sells one
Call at a Strike Price above which the price of the underlying is
not expected to go & hence also covering for the premium paid.
Mkt Price Premium Long Call Short Call Profit / Loss
90 -3 - - -3100 -3 - - -3
103 -3 100 - 0
110 -3 100 - 7
120 -3 100 - 17
130 -3 100 120 17
Strike Price (Long Call) 100
Strike Price (Short Call) 120
Premium (Long Call) 10Premium (Short Call) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call
Short Call
Overall Profit
Bull Spread
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Bear Spread: A strategy in which Option to sell is bought (Long
Putt) & sold (Short Putt) but at a diff. strike price. Investor thinks
that market will not rise but wants to limit his risk by getting the
premium on Putt sold. Maximum Profit on Lower Strike price.
Important Points:
Outlook: Bearish
Max Profit: At Lower Strike Price.
Max Loss: Limited to the difference in premium.
Motivation: Expectation is that the price of the underlying is
going to fall in the future, so a Putt is purchased. Investor also
wants to cover the premium loss on Long Putt, so he sells one
Putt at a Strike Price below which the price of the underlying is
not expected to go & hence also covering for the premium paid.
Mkt Price Premium Long Putt Short Putt Profit / Loss
80 3 120 100 1790 3 120 100 17
100 3 120 - 17
110 3 120 - 7
117 3 120 - 0
130 3 - - -3
Strike Price (Long Putt) 120
Strike Price (Short Putt) 100
Premium (Long Putt) 10Premium (Short Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Put
Short Put
Overall Profit
Bear Spread
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Long Straddle: A strategy in which both option to buy & sell
are bought at same strike price (Long Call & Long Putt).
Investor is expecting market to be very volatile.
Important Points:
Outlook: Very Volatile
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0.
Motivation: Expectation is that the market would be very
volatile & investor does not have any clue about the direction in
which its going to go. Hence he purchases a Call as well a Putt.
But in this case it is to be noted that premium for this strategy is
very high as the buyer of the option can always exercise the
option whether market moves up or down as he has purchased
both Call & Putt.
Mkt Price Premium Long Call Long Putt Profit / Loss
70 -17 - 100 1383 -17 - 100 0
100 -17 - - -17
110 -17 100 - -7
117 -17 100 - 0
150 -17 100 - 33
Strike Price 100
Premium (Long Call) 10
Premium (Long Putt) 7
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call
Long Put
Overall Profit
Long Straddle
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Short Straddle: A strategy in which both option to buy &sell are sold at same strike price (Short Call & Short Putt).
Investor is expecting market to be very stable.
Important Points:
Outlook: Stable
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0.
Motivation: Expectation is that the market would bestable & hence both Call & Putt are sold for a very high
premium charged. Here it is expected that market would
not move drastically in any direction & hence premium can
be earned by selling Call & Putt.
Mkt Price Premium Short Call Short Putt Profit / Loss
70 17 - 100 -1383 17 - 100 0
100 17 - - 17
110 17 100 - 7
117 17 100 - 0
150 17 100 - -33
Strike Price 100
Premium (Short Call) 10
Premium (Short Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call
Short Put
Overall Profit
Short Straddle
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Long Strangle: This strategy is same as Long Straddle. The only
difference being Different Strike prices for Long Call & Long
Putt. Premium charged here is less than Long Straddle as the
seller of the option has better chance of staying In the Money dueto gap b/w two Strike Prices.
Important Points:
Outlook: Very Volatile
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0.
Motivation: Motivation behind this strategy is same as Long
Straddle. The only difference is that the strike price for Long
Call & Long Putt is different. Due to this seller of the option has
better chance of staying in the money, and hence premium
charged on this is relatively lower than Straddle. Also for the
Buyer to exercise this option, price of the underlying will have tomove drastically for him to be in the money.
Mkt Price Premium Long Call Long Putt Profit / Loss
70 -17 - 100 1383 -17 - 100 0
100 -17 - - -17
110 -17 - - -17
137 -17 120 - 0
150 -17 120 - 13
Strike Price (Long Call) 120
Strike Price (Long Putt) 100
Premium (Long Call) 10
Premium (Long Putt) 7
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call
LongPut
Overall Profit
Long Strangle
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Short Strangle: This strategy is same as Short Straddle. The
only difference being Different Strike prices for Short Call &
Short Putt. Premium charged here is less than Short Straddle as
the seller of the option has better chance of staying In the Moneydue to gap b/w two Strike Prices.
Important Points:
Outlook: Stable
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0.
Motivation: Motivation behind this strategy is same as Long
Straddle. Here it is expected that market would not move
drastically in any direction & hence premium can be earned by
selling Call & Putt. Premium earned here would be less than
Straddle as seller has better chance to be in the money in this
option.
Mkt Price Premium Short Call Short Putt Profit / Loss
70 17 - 100 -13
83 17 - 100 0
100 17 - - 17
110 17 - - 17
137 17 120 - 0
150 17 120 - -13
Strike Price (Short Call) 120
Strike Price (Short Putt) 100
Premium (Short Call) 10Premium (Short Putt) 7
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call
Short Put
Overall Profit
Short Strangle
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Long Strip: A strategy in which 1 Call & 2 Putts are bought.
Investor thinks that market would be volatile but is more likely
to fall.
Important Points:
Outlook: Volatile & Slightly Bearish
Max Profit: Limited & maximum when Mkt Price = 0 for Putt
& Unlimited for Call.
Max Loss: Limited to the premium paid.
Motivation: Expectation is that the market will be volatile but
price of the underlying is more likely to fall than rise in the
future, so 2 Putt options are bought to hedge against the fall in
the prices. A Call option is also bought to hedge against the
volatility in the market. Investor buys 2 Putt options & 1 Call
option as price of the underlying is more likely to fall than rise
in the future.
Mkt Price Premium Long Call Long Putt (2) Profit / Loss
70 -24 - 100 3688 -24 - 100 0
100 -24 - - -24
110 -24 100 - -14
124 -24 100 - 0
150 -24 100 - 26
Strike Price 100
Premium (Long Call) 10
Premium (Long Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call
Long Put(2)
Overall Profit
Long Strip
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Short Strip: A strategy in which 1 Call & 2 Putts are sold.
Investor thinks that market would be stable and is more likely
to rise.
Important Points:
Outlook: Stable & Slightly Bullish
Max Profit: Limited to the premium received.
Max Loss: Limited & Maximum when Mkt Price = 0 for Putt& Unlimited for Call.
Motivation: Expectation is that the price of the underlying
would not change much as it is expected that market would be
stable. If it does change in the future its more likely to rise
than fall and hence 1 Call option & 2 Putt options are sold.
Mkt Price Premium Short Call Short Putt (2) Profit / Loss
70 24 - 100 -36
88 24 - 100 0
100 24 - - 24
110 24 100 - 14
124 24 100 - 0
150 24 100 - -26
Strike Price 100
Premium (Short Call) 10
Premium (Short Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call
Short Put(2)
Overall Profit
Short Strip
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Long Strap: A strategy in which 1 Putt & 2 Calls are bought.
Investor thinks that market would be volatile but is more
likely to rise.
Important Points:
Outlook: Volatile & Slightly Bullish
Max Profit: Unlimited for Calls & Limited & maximum
when Mkt Price = 0 for Putt.
Max Loss: Limited to the premium paid.
Motivation: Expectation is that the market will be volatile but
price of the underlying is more likely to rise than fall in the
future, so 2 Call options are bought to hedge against the rise in
the prices. A Putt option is also bought to hedge against the
volatility in the market. Investor buys 2 Call options & 1 Putt
option as price of the underlying is more likely to rise than fall
in the future.
Mkt Price Premium Long Call Long Putt (2) Profit / Loss
70 -24 - 100 36
88 -24 - 100 0
100 -24 - - -24
110 -24 100 - -14
124 -24 100 - 0
150 -24 100 - 26
Strike Price 100
Premium (Long Call) 10
Premium (Long Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Call (2)
Long Put
Overall Profit
Long Strap
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Short Strap: A strategy in which 1 Putt & 2 Calls are sold.
Investor thinks that market would be stable and is more likely
to fall.
Important Points:
Outlook: Stable & Slightly Bearish
Max Profit: Limited to the premium received.
Max Loss: Unlimited for Calls & Limited & maximum whenMkt Price = 0 for Putt.
Motivation: Expectation is that the price of the underlying
would not change much as it is expected that market would be
stable. If it does change in the future its more likely to fall
than rise and hence 1 Putt option & 2 Call options are sold.
Mkt Price Premium Long Call Long Putt (2) Profit / Loss
70 -24 - 100 36
88 -24 - 100 0
100 -24 - - -24
110 -24 100 - -14
124 -24 100 - 0
150 -24 100 - 26
Strike Price 100
Premium (Long Call) 10
Premium (Long Putt) 7
Example:
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call (2)
Short Put
Overall Profit
Short Strap
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Long Butterfly: A strategy in which 1 Call Option is
bought at a High Strike Price & 1 at a Low Strike
Price & 2 Call Options are sold at a Strike Price
which is b/w the High Strike Price & Low StrikePrice. Investor expects market to be very Volatile &
doesnt know the direction in which its heading.
Important Points:
Outlook: Very VolatileMax Profit: Limited & maximum at the strike price
at which 2 Calls are sold.
Max Loss: Limited to the difference of premium
paid & received.
Motivation: Expectation is that the market would be
very volatile & investor does not want to take any
risk is such situation. So he enters in to this strategy
where both Profit & Loss is limited & investor has
an idea of the maximum loss that can be suffered.
This is low risk, low return strategy. Investors
position is perfectly hedged against volatility in this
strategy but this is also very difficult to implement.
Mkt Price Premium
Long Call
(100)
Short Call
(120)
Long Call
(140) Profit / Loss
100 -3 - - - -3
103 -3 100 - - 0115 -3 100 - - 12
120 -3 100 - - 17
130 -3 100 120 - 7
160 -3 100 120 140 -3
Strike Price (Long Call 1) 100
Strike Price (Short Call) 120
Strike Price (Long Call 2) 140Premium (Long Call 1) 15
Premium (Short Call) 10
Premium (Long Call 2) 8
Example:
Long Call (15)
Long Call (35)
2 Short Call (25)
Overall Profit
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-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Long Butterfly
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Short Butterfly: A strategy in which 1 Call Option
is sold at a High Strike Price & 1 at a Low Strike
Price & 2 Call Options are bought at a Strike Price
which is b/w the High Strike Price & Low StrikePrice. Investor expects market to be very Volatile &
doesnt know the direction in which its heading.
Important Points:
Outlook: Very Volatile
Max Profit: Limited & maximum at the strike priceat which 2 Calls are purchased.
Max Loss: Limited to the difference of premium
paid & received.
Motivation: Expectation is that the market would be
very volatile & motivation is very similar to Long
Butterfly, the difference is just in the
implementation of the strategy. Here he sells a Call
at High & Low Strike prices each & buys 2 Calls ata Strike Price b/w High 7 Low Strike Price which is
vice versa in Long Butterfly.
Mkt Price Premium
Long Call
(100)
Short Call
(120)
Long Call
(140) Profit / Loss
100 -3 - - - -3
103 -3 100 - - 0
115 -3 100 - - 12
120 -3 100 - - 17
130 -3 100 120 - 7
160 -3 100 120 140 -3
Strike Price (Long Call 1) 100
Strike Price (Short Call) 120
Strike Price (Long Call 2) 140
Premium (Long Call 1) 15
Premium (Short Call) 10
Premium (Long Call 2) 8
Example:
-30
-25
-20
-15
-10
-5
0
5
10
15
20
25
30
0 5 10 15 20 25 30 35 40
Short Call (15)
Short Call (35)
2 Long Call (25)
Overall Profit
Short Butterfly