Post on 04-Jun-2018
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Advanced Option Strategies
Derivatives and Risk Management
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Outline
Principles of Money Spreads and combinations
Bull spread
Bear spread
Butterfly Spread Calendar spreads
Combinations
Collars
Straddle Strips and straps
strangles
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Option Spreads
What do we mean by a spread?
Types of Spreads
Vertical/Money Spread
Horizontal Spread
Buying the Spread
Selling the Spread
Why use spreads?
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Money Spreads
Bull Spreads
Bear Spreads
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Bull Spread
Creating Bull spread with calls
Buy a call option on a stock with a certain
exercise price and sell a call option on the same
stock with a higher exercise price Example
Creating Bull spread with puts
Buy a put with a low strike price and sell a put witha high strike price
Example
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Bear Spread
Bearish on stock
Creating bear spread with puts
Buy a put with a high exercise price and sell a put
with a low exercise price
Example
Creating bear spread with calls
Buy a call with higher exercise price and sell a callwith a lower exercise price
Example
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Butterfly Spread
Involves two positions in options with three different
exercise prices
Buy a call with a relatively low exercise price, say E1
Buy a call with a relatively high exercise price, sayE3, and
Sell two calls with a strike price of E2
Usually, E2 is halfway between E1 and E3
E2 is usually close to the current stock price
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A butterfly spread leads to a profit if the stock price
stays close to E2, but
Gives a small loss if there is a significant movement
in either direction Good strategy if you feel significant stock price
changes are unlikely
Require small investment initially to setup the
spread
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Butterfly Spread
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Breakeven Point
Upper Breakeven Point = Strike Price of Higher
Strike Long Call - Net Premium Paid
Lower Breakeven Point = Strike Price of LowerStrike Long Call + Net Premium Paid
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Calendar Spread
Sell a call option with a certain exercise price
and
Buy a longer maturity call option with the
same strike price
Longer the maturity of the option bought, the
more expensive it is due to speculative value
of the option Requires initial investment to setup
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Assuming that the long-maturity option is sold
when the short-maturity option matures,
What will be the payoff diagram?
How to determine profit/loss?
Types of Calendar Spreads
Neutral Calendar Spreads
Bullish Calendar Spread Bearish Calendar Spread
Calendar Spread with Put Options
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Reverse Calendar Spread
If you anticipate the stock price to move into
in extremes, you can execute a reverse
calendar spread
Buy a call with a shorter maturity and
Sell a call with a longer maturity with the
same exercise price
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Combinations
Combination is an option trading strategy that
involves taking a position in both calls and
puts on the same stock
Straddle
Strips
Straps
Strangles Collars
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Straddle
Buy a call and buy a put with the same strike
price and expiration date
When do you profit?
When to use this strategy?
Breakeven points Upper Breakeven Point = Strike Price of Long Call + Net
Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net
Premium Paid
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Payoff diagram
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Short a straddle
Sale of a put and a call with the same
exercise price and expiration date
High risk strategy, especially if the stock price
moves too much
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Strips and Straps
Strip
Long position in one call and two puts with the
same strike price and expiration date
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Upper Breakeven Point = Strike Price of
Calls/Puts + Net Premium Paid
Lower Breakeven Point = Strike Price of
Calls/Puts - (Net Premium Paid/2)
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Strap
A long position in two calls and one put with the
same strike price and maturity
Upper Breakeven Point = Strike Price ofCalls/Puts + (Net Premium Paid/2)
Lower Breakeven Point = Strike Price of
Calls/Puts - Net Premium Paid
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Payoff diagram of a Strap
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Strangle
Buy a put and a call with the same maturity
date, but different strike prices
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Breakeven Point
Upper Breakeven Point = Strike Price of Long
Call + Net Premium Paid
Lower Breakeven Point = Strike Price of Long
Put - Net Premium Paid
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Collars
Buy a stock
Buy a put on the stock with an exercise price
lower than the current stock price
Sell a call on the stock with an exercise price
higher than the current stock price
Choose the call exercise price in such a
manner that the call premium completelyoffsets the put premium
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= Ns(STS) + NP[MAX(0, E1 - ST) P1] Nc[max(0, STE2) C2]
If stock price at maturity is below both theexercise prices?
If the stock price at maturity is between thetwo exercise prices
If the stock price at maturity is higher thanboth the exercise prices
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Payoff diagram of a Collar