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Date Submitted: 07/26/2010 11:01 AM
Trading Strategies Involving Options
Lecture 3
1
Three Alternative Strategies
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)
2
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
3
(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:
5
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
7
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...