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4 4 Advanced Option Strategies
4 4 Advanced Option Strategies
4 4 Advanced Option Strategies
Outline
Option Spreads
Money Spreads
Bull Spread
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
Buy a put with a low strike price and sell a put with a high strike price
Example
Bear Spread
Buy a put with a high exercise price and sell a put with a low exercise price
Buy a call with higher exercise price and sell a call with a lower exercise price
Example
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, say E3, 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
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
Butterfly Spread
Breakeven Point
Upper Breakeven Point = Strike Price of Higher Strike Long Call - Net Premium Paid Lower Breakeven Point = Strike Price of Lower Strike Long Call + Net Premium Paid
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
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? Neutral Calendar Spreads Bullish Calendar Spread Bearish 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
Combinations
Combination is an option trading strategy that involves taking a position in both calls and puts on the same stock
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
Payoff diagram
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
Strip
Long position in one call and two puts with the same strike price and expiration date
Upper Breakeven Point = Strike Price of Calls/Puts + Net Premium Paid Lower Breakeven Point = Strike Price of Calls/Puts - (Net Premium Paid/2)
Strap
A long position in two calls and one put with the same strike price and maturity Upper Breakeven Point = Strike Price of Calls/Puts + (Net Premium Paid/2) Lower Breakeven Point = Strike Price of Calls/Puts - Net Premium Paid
Strangle
Buy a put and a call with the same maturity date, but different strike prices
Breakeven Point
Upper Breakeven Point = Strike Price of Long Call + Net Premium Paid Lower Breakeven Point = Strike Price of Long Put - Net Premium Paid
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 completely offsets the put premium
= Ns (ST S) + NP[MAX(0, E1 - ST) P1] Nc[max(0, ST E2) C2] If stock price at maturity is below both the exercise prices? If the stock price at maturity is between the two exercise prices If the stock price at maturity is higher than both the exercise prices