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Submitted to:
SARDAR PATEL COLLEGE OF ADMINISTRATION & MANAGEMENT
(SPCAM-MBA)
AFFILIATED WITH GUJARAT TECHNOLOGIACAL UNIVERSITY, AHMEDABAD
Prepared by:Vishal H Patel Ankit B PatelEnrl No.:107550592018 Enrl No.:107550592024MBA-II (2010-2012) MBA-II (2010-2012)
PRESENTATION
ON
TRADING STRATEGIES INVOLVING OPTIONS
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8.2
Three Alternative Strategies
Take a position in the option & theunderlying
Take a position in 2 or moreoptions of the same type (Aspread)
Combination: Take a position in amixture of calls & puts (Acombination)
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8.3
a) LONG POSITION IN A STOCK + SHORT A CALL
b) SHORT POSITION IN A STOCK + LONG A CALL
c) LONG POSITION IN A STOCK + LONG A PUT
d) SHORT POSITION IN A STOCK + SHORT A PUT
DIFFERENT WAYS OF PROTECTIVE
INVESTMENT (COVERED)
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Options, Futures, and Other Derivatives, 4th edition 1999 by John C. Hull
8.5Positions in an Option & the
Underlying
Profit
STX
Profit
ST
X
Proft
ST
X
Profit
ST
X
(a)(b)
(c) (d)
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8.6
SPREADS
A spread strategy involves taking a position in 2 or more options
of the same type (2 or more calls or 2 or more puts)
BULL SPREADS (hoping for a increase)
BEAR SPREADS (hoping for a decrease)
BUTTERFLY SPREADS (hoping for no major move)
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8.7
BULL MARKET
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8.8
BEAR MARKET
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8.9
WHICH ONE OF THE 2 CALLS IS HIGHER ?
MARCH 30 CALL OR MARCH 35 CALL ?
MARCH 30, because strike price is lower
THE LOWER THE STRIKE PRICE, THE HIGHER THE CALL PRICE FOR THE SAME
MATURITY
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8.10
BULL SPREADS
Buying a call option with a certain strike price and
selling a call option with a higher strike price
(Example : Buy a march 30 call and sell a March 35 call)
Value of purchased call > Value of sold call
Requires an initial investment
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8.11
Bull Spread Using Calls
X1 X2
Profit
ST
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8.12EXAMPLE (bull spreads using calls)
A trader buys a Home depot (HD) 30 Call at $5 and sells aHD 35 Call at $3.
Cash Flow : $-2
If St 30 Profit = $-2
30
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8.13
BULL SPREADS
USING PUTSBuying a put option with a low strike price and selling a put option
with a high strike price
(Example : Buy a march 30 put and sell a March 35 put)
Value of purchased put < Value of sold put
PROVIDES A POSITIVE CASH FLOW
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8.14
Bull Spread Using Puts
X1 X2
Profit
ST
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8.15EXAMPLE( bull spread using puts)
A trader buys a HD 30 Put at $5 and sells a HD 35Put at $8
Cash Flow : $3
If S0 30 Profit = $-2
30
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8.16
BEAR SPREADS
A trader entering into a bear spread is hoping that the stock price
will decrease.
Buying a call option with a certain strike price and selling a call optionwith a lower strike price
(Example : Buy a March 35 call and sell a March 30 call)
Value of purchased call < Value of sold call
A bear spread limits the traders upside potential as well
as downside risk
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8.17
Bear Spread Using Calls
X1 X2
Profit
ST
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8.19
Bear Spread Using Puts
X1 X2
Profit
ST
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8.20EXAMPLE (Bear spreads using puts)
A trader buys a HD 35 Put at $3 and sells a HD 30Put at $1
Cash Flow : -$2
If S0 30 Profit = $3
30
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8.21BUTTERFLY SPREADSAButterfly spreadinvolves positions in options with 3 different strike
prices.
BUY 1 CALL WITH A LOW STRIKE PRICE X1.
BUY 1 CALL WITH A HIGH STRIKE PRICE X3SELL 2 CALL OPTIONS WITH A STRIKE PRICE X2
(usually X2 is close to the stock price)
PROFIT IF THE STOCK PRICE STAYS CLOSE TO X2
APPROPRIATE STRATEGY IF NO LARGE
MOVEMENT IS EXPECTED IN EITHER DIRECTION
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8.22
Butterfly Spread Using Calls
X1 X3
Profit
STX2
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8.23
EXAMPLE
Suppose S0= $61 and you dont expect any major move in either
direction in the next 6 months (you trade with 6 month away options)
What strike price would you chose in considering a butterfly
spread using calls ?
BUY ONE 55 CALL OPTION
BUY ONE 65 CALL OPTION
SELL TWO 60 CALL OPTION
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8.24
BUY 55 CALL AT $10
SELL TWO 60 CALLS AT $7
BUY 65 CALL AT $5
WHAT IS THE COST OF THIS BUTTERFLY SPREAD ?
-10 + 14 - 5 = -1
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8.25
IF S0 > $65, THEN NET PROFIT IS -1
IF S0 < $55, THEN NET PROFIT IS -1
The ideal situation is when S0 is at $60 at expiration of theOptions. Profit is then :
$4
A profit is realized if 55
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8.26
DONT FORGET..WHEN TO USE BUTTERFLY
SPREAD
WHEN YOU THINK THE MARKET WILL NOT MOVE
VIOLENTLY IN ANY DIRECTION
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8.27
Butterfly Spread Using Puts
X1
X3
Profit
STX2
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8.28
COMBINATIONS
A Combination is an option trading strategy that involves taking
a position in both calls and puts on the same stock.
STRADDLES STRANGLES
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8.29
STRADDLES
A straddle is appropriate when a trader
expects a large movement but doesnt know in
which direction
BUYING A CALL AND A PUT
SELLING A CALL AND A PUT
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8.30EXAMPLESuppose S0 trades at $69 and a trader expects a strong move in either
direction (takeover or earning disappointment).
The trader could create a 3 months straddle buy:
NET COST IS :$7
Buying a call 70 at $4Buying a put 70 at $3
BREAKEVEN POINTS : $77 and $63
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8.31
A Straddle Combination
Profit
ST
X
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8.32
STRANGLES
In a Strangle, a trader buys a put and a call with different strike prices,but same expiration dates. The Call strike price is higher than the Put
strike price.
BUYS A MARCH 35 CALL
BUYS A MARCH 30 PUT
LESS EXPENSIVE THAN A STRADDLE
Profit depends on how far apart the strike prices are
The farther apart they are, the less downsize risk , and the further the stock price has to
move for a profit to be realized.
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8.33
A Strangle Combination
X1 X2
Profit
ST
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8.34