Chapter 12
Trading Strategies Involving Options
Options, Futures, and Other
Derivatives, 9th Edition, Copyright ©
John C. Hull 2014
1
Principal Protected Note
• Allows investor to take a risky position without risking any principal
• Example: $1000 instrument consisting of
• 3-year zero-coupon bond with principal of $1000
• 3-year at-the-money call option on a stock portfolio currently worth $1000
Options, Futures, and Other
Derivatives, 9th Edition, Copyright ©
John C. Hull 2014
2
Option strategies
Three types:
• A single option and the underlying asset
• Two or more options of the same type
• A mixture of calls and puts
3
Strategies involving a single option and a
stock Writing a covered call
• Construction:
• Long a stock
• Short a call on a stock
• The profit patterns are similar to
the profit patterns of a short put
Figure 11.1(a), page 246
4
Strategies involving a single option and a stock
Protective Put
• Construction:
• Long a stock
• Long a put on a stock
• The profit patterns are similar to
the profit patterns of a long call
Figure 11.1(c), page 246
5
Spreads
Bull spread using calls
• Construction:
• Long a call with a strike price K1
• Short a call with a strike price K2
• Both options have the same
expiration date
• Requires an initial investment
• Limits the investor’s upside and
downside risk
• Market outlook: stock price will
increase
• Figure 11.2, page 247
6
Spreads
Bull spread using calls (cont.)
•
Payoff from a bull spread created using calls
•
7
Spreads
Bull spread using puts
• Construction:
• Long a put with a strike price K1
• Short a put with a strike price K2
• Both options have the same
expiration date
• Involves an initial cash inflow
8
Spreads
Bear spread using puts
• Construction:
• Short a put with a strike price K1
• Long a put with a strike price K2
• Both options have the same
expiration date
• Requires an initial investment
• Limits the upside profit potential
and the downside risk
• Market outlook: stock price will
decline
9
Spreads
Bear spread using puts (cont.)
•
Payoff from a bear spread created using puts
•
10
Spreads
Bear spread using calls
• Construction:
• Short a call with a strike price K1
• Long a call with a strike price K2
• Involves an initial cash inflow
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Spreads
Box spread
• Construction:
• Bull call spread with strike prices K1 and K2
• Bear put spread with the same strike prices K1 and K2
•
Payoff from a box spread
Table 11.3, page 251
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Spreads
Butterfly spread using calls
• Construction:
•
•
•
•
Long a call with a strike price K1
Long a call with a strike price K3
Short two calls with a strike price K2
K2=(K1+K3)/2
• Requires an initial investment
• Market outlook: large stock price
moves are unlikely
13
Spreads
Butterfly spread using calls (cont.)
•
Payoff from a butterfly spread created using calls
•
14
Spreads
Butterfly spread using puts
• Construction:
•
•
•
•
Long a put with a strike price K1
Long a put with a strike price K3
Short two puts with a strike price K2
K2=(K1+K3)/2
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Spreads
Calendar spread using calls
• Construction:
• Short a call with a strike price K and
maturity T1
• Long a call with a strike price K and
maturity T2
• Requires an initial investment
16
Spreads
Calendar spread using puts
• Construction:
• Short a put with strike price K and
maturity T1
• Long a put with strike price K and
maturity T2
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Straddle
• Construction:
• Long a call with a strike price K and
maturity T
• Long a put with a strike price K and
maturity T
• Market outlook: expecting a
large move in a stock price in
either direction
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Straddle (cont.)
•
Payoff from a straddle
•
19
Strips
• Construction:
• Long one call with a strike price K
and maturity T
• Long two puts with a strike price K
and maturity T
• Market outlook: big stock price
move; a decrease in the stock
price is more likely than an
increase
20
Straps
• Construction:
• Long two calls with a strike price K
and maturity T
• Long one put with a strike price K
and maturity T
• Market outlook: big stock price
move; an increase in the stock
price is more likely than a
decrease
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Strangles
• Construction:
• Long a put with a strike price K1 and
maturity T
• Long a call with a strike price K2 and
maturity T
• Market outlook: a large price
move, but uncertainty about the
direction
22
Strangles (cont.)
Payoff from a strangle
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