finquiz - smart summary_ study session 17_ reading 59

2015, Study Session # 17, Reading # 59

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“RISK MANAGEMENT APPLICATIONS OF OPTION STRATEGIES”

59.a

� Maximum loss for long on call = c0.

� Breakeven = X+c0 (call price/option price).

� Potential profit for long & potential loss for short is theoretically unlimited.

� ST > X at expiration ⇒ holder of call will exercise the option.

� For short max profit = C0.

� Long profit (loss) = short loss (profit) ⇒ zero sum game.

Call Option: Profit & Loss

� Maximum loss for buyer of put (long) = p0.

� Maximum gain for long = X-p0.

� Maximum gain for long = maximum loss for short.

� Breakeven = X-p0.

� Max gain for short = p0.

� Long profit (loss) = short loss (profit) ⇒ zero sum game.

� Underlying asset price � ⇒ buyer of put (long), seller of the call (short) ⇒ profit.

� Underlying asset price � ⇒ long call & short put ⇒ profit.

� Generally long put perceives asset price will � & short put perceives asset price will�.

Put Option: Profit & Loss

59.b

� Buy stock and sell (write) call option.

� Stock will be used for delivery.

� Assumption: stock price will not go up soon.

� Call premium received ⇒ increase income.

� Stock’s upside potential is traded against call premium.

� Upside potential (limited to) ⇒ X– So + c0.

� Maximum loss = So – c0.

Covered Call

� Buying a stock + buying a put (long).

� Investment management technique ⇒ protects a stock from � in value.

� Limited downside loss against unlimited upside gain.

� Breakeven = So + c0.

� Stock price > breakeven ⇒ profit

� Maximum loss = (So-X) + p0 paid.

� Maximum loss occurs when current price < X.

Protective Put

So = Stock Price at Time

Zero (Initial)

X = Strike/Exercise Price

OP = Option Premium