 Group 5

 Anmol Sahiwal
 Ridhi Dugar
 Saurabh Nipane
 Shrutin Pandya
 Namrata Shruti
 Prachi Bais
 Rahbaaz Aboobacker
 Shrikanth
 Option spreads are strategies in which the
player is simultaneously long and short
options of the same type, but with different
◦ Striking prices or
◦ Expiration dates
 the ‘spreader’ establishes a known maximum
profit or loss potential between either the two
strike prices or the two expiration dates…or
combination thereof
 Spreads are also known as ‘collars’
 Price spreads
 Calendar spreads
 Diagonal spreads
 Butterfly spreads
 Bullspread
 Bearspread
 Assume a person believes a stock will
appreciate soon
 A possible strategy is to construct a vertical
call bull spread and:
◦ Buy an OCT 85 call
◦ Write an OCT 90 call
 The spreader trades part of the profit
potential for a reduced cost of the position.
 With all spreads the maximum gain and loss
occur at the striking prices

◦ It is not necessary to consider prices outside this

range
◦ With an 85/90 spread, you only need to look at the
stock prices from Rs85 to Rs90
 a profit and loss worksheet to form the bull
spread

Stock Price at Option Expiration

0 85 86 88 90 100
Long Rs85 -5 -5 -4 -2 0 10
call
@ Rs5
Short Rs90 4 4 4 4 4 -6
call
@ Rs4
Net -1 -1 0 2 4 4
 Bull spread
 A bear spread is the reverse of a bull spread

◦ The maximum profit occurs with falling prices

◦ The investor buys the option with the higher
striking price and writes the option with the lower
striking price
◦ Profit from the sale of the call w/o risk of a sharp
run up in the price of the stock
 Involves using puts instead of calls

 Buy the option with the lower striking price

and write the option with the higher one
 Profit stems from the spread of the two
options
but profit still only is generated if the stock
moves up (bull put spread)
 The put spread results in a credit to the
spreader’s account (credit spread)

 The call spread results in a debit to the

spreader’s account (debit spread)
 A general characteristic of the call and put
bull spreads is that the profit and loss
payoffs for the two spreads are
approximately the same

◦ The maximum profit occurs at all stock prices

above the higher striking price
◦ The maximum loss occurs at stock prices below the
lower striking price
 In a calendar spread, options are chosen
horizontally from a given row in the financial
pages
◦ They have the same striking price
◦ The spreader will long one option and short the
other
 The trading objective is to take advantage of
the ‘time decay’ factor.
◦ Options are worth more the longer they have until
expiration
 Calendar spreads are either bull spreads or
bear spreads

◦ In a bull spread, the spreader will buy a call with a

distant expiration and write a call that is near
expiration
◦ In a bear spread, the spreader will buy a call that is
near expiration and write a call with a distant
expiration…..taking advantage of the greater time
value
 A diagonal spread involves options from
different expiration months and with
different striking prices
◦ They are chosen diagonally from the option listing
in the financial pages

 Diagonal spreads can be bullish or bearish

 A butterfly spread can be constructed for very
little cost beyond commissions
 A butterfly spread can be constructed using
puts and calls
 A butterfly spread does not technically meet
the definition of a spread in that it can
involve both puts and calls (combination)
 Volatility of the stock price is the main driver
of the profit/loss potential with this option
strategy
 Example of a butterfly spread
 Straddles
 Strangles

 A combination is defined as a strategy in

which you are simultaneously long or short
options of different types
 A straddle is the best-known option
combination

 You are long a straddle if you own both a put

and a call with the same
◦ Striking price
◦ Expiration date
◦ Underlying security
 You short a straddle if you short both a put
and a call with the same

◦ Strike price
◦ Expiration date
◦ Underlying security
 A long call is bullish
 A long put is bearish
 Why buy a long straddle?
◦ Whenever a situation exists when it is likely that a
stock will move sharply one way or the other
 Very Speculative - typically a situation where
a company is involved in a lawsuit or takeover
- unclear how the situation will be resolved.
 Suppose a speculator

◦ Buys an OCT 80 call @ Rs7

◦ Buys an OCT 80 put @ Rs6
 A profit and loss worksheet to form the long
straddle:

Stock Price at Option Expiration

0 50 75 80 90 100

Buy Rs80 call -7 -7 -7 -7 3 13

@ Rs7
Buy Rs80 put 74 24 -1 -6 -6 -6
@ Rs6
Net 67 17 -8 -13 -3 7
 Long straddle
 The worst outcome for the straddle buyer is
when both options expire worthless
◦ Occurs when the stock price is at-the-money

 The straddle buyer will lose money if MSFT

closes near the striking price
◦ The stock must rise or fall to recover the cost of the
initial position
 If the stock rises, the put expires worthless,
but the call is valuable

 If the stock falls, the put is valuable, but the

call expires worthless
 Popular with speculators
 The straddle writer wants little movement in
the stock price
 Losses are potentially unlimited on the upside
because the short call is uncovered
 Short straddle
 A strangle is similar to a straddle, except the
puts and calls have different striking prices

 Strangles are more popular due to the smaller

capital investment and the max. gain occurs
over a wider trading range
 The speculator long a strangle expects a
sharp price movement either up or down in
the underlying security

 Suppose a speculator:

◦ Buys a OCT 75 put @ Rs4

◦ Buys a OCT 85 call @ Rs5
 Long strangle
 The maximum gains for the strangle writer
occurs if both option expire worthless
◦ Occurs in the price range between the two exercise
prices
◦ similar to writing a straddle
◦ some movement in the stock price results in the
max. Profit
◦ maximum profit is somewhat reduced from the
straddle
 Short strangle