Options Trading Strategies

Trading Strategies Involving Options

Lecture 3

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Three Alternative Strategies

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Take a position in the option and the underlying Take a position in 2 or more options of the same type (A spread) Combination: Take a position in a mixture of calls & puts (A combination)

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Positions in an Option & the Underlying (Figure 10.1, page 220)

Long stock

Profit

Profit

Long call

K K

(a) Profit

ST

Short call Long stock

ST

(b) Profit

Short stock Short stock

K

Long put

Short put

ST

K

(d)

ST

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(c)

Bull Spread Using Calls

(Figure 10.2, page 221) Buying a Call with low strike price, selling a Call with higher strike price

Profit

Short call, strike K2

ST K1 K2

Long call, strike, K1 4

Bull spread using call options An investor buys for $3 a call with a strike price of $30 And sells for $1 a call with a strike price of $35. The payoff from this bull spread strategy is $5 if the stock price is above $35 and zero if it is below $30 If the stock price is between $30 and $35, the payoff is the amount by which the stock price exceeds $30. The cost of the strategy is $3 - $1 = $2. The payoff is therefore:

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Initial cost $2 Stock price ST ≤ 30 30 < ST < 35 ST ≥ 35 Payoff 0 ST - 30 $5 Profit -2 ST – 32 +3

Profit

Short call, strike K2

ST

K1=$30 K2=$35

Long call, strike, K1 6

Bull Spread Using Puts

Figure 10.3, page 222 Buying a Put with low strike price, selling a Put with higher strike price

Profit K1

Short Put, Strike K2

K2

ST

Long Put, Strike K1

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Suppose that put options on a stock with strike price $30 and $35 cost $4 and $7, respectively. How can the options be used to create a bull spread? A bull spread is created by buying the $30 put and selling the $35 put. The outcome is as follows: The payoff from this bull spread strategy is zero if the stock price is above $35 and -5 if it is below $30 If the stock price is between $30 and $35, the payoff is the...