Chapter 12
Trading Strategies Involving
Options
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
1
Strategies to be Considered
Bond plus option to create principal
protected note
Stock plus option
Two or more options of the same type (a
spread)
Two or more options of different types (a
combination)
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
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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
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Principal Protected Notes continued
Viability depends on
Level of dividends
Level of interest rates
Volatility of the portfolio
Variations on standard product
Out of the money strike price
Caps on investor return
Knock outs, averaging features, etc
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
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Positions in an Option & the Underlying
(Figure 12.1, page 257)
Profit
Profit
K
K
ST
ST
(a)
(b)
Profit
Profit
K
ST
(c)
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
K
ST
(d)
5
Bull Spread Using Calls
(Figure 12.2, page 258)
Profit
ST
K1
K2
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
6
Bull Spread Using Puts
Figure 12.3, page 259
Profit
K1
K2
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
ST
7
Bear Spread Using Puts
Figure 12.4, page 260
Profit
K1
K2
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
ST
8
Bear Spread Using Calls
Figure 12.5, page 261
Profit
K1
K2
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
ST
9
Box Spread
A combination of a bull call spread and a bear
put spread
If all options are European a box spread is
worth the present value of the difference
between the strike prices
If they are American this is not necessarily so
(see Business Snapshot 11.1)
Options, Futures, and Other Derivatives, 9th Edition,
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Butterfly Spread Using Calls
Figure 12.6, page 262
Profit
K1
K2
K3
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
ST
11
Butterfly Spread Using Puts
Figure 12.7, page 264
Profit
K1
K2
K3
Options, Futures, and Other Derivatives, 9th Edition,
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ST
12
Calendar Spread Using Calls
Figure 12.8, page 265
Profit
ST
K
Options, Futures, and Other Derivatives, 9th Edition,
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Calendar Spread Using Puts
Figure 12.9, page 266
Profit
ST
K
Options, Futures, and Other Derivatives, 9th Edition,
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14
A Straddle Combination
Figure 12.10, page 267
Profit
K
Options, Futures, and Other Derivatives, 9th Edition,
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ST
15
Strip & Strap
Figure 12.11, page 268
Profit
Profit
K
Strip
ST
K
ST
Strap
Options, Futures, and Other Derivatives, 9th Edition,
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16
A Strangle Combination
Figure 12.12, page 269
Profit
K1
K2
ST
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
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Other Payoff Patterns
When the strike prices are close together a
butterfly spread provides a payoff consisting
of a small “spike”
If options with all strike prices were available
any payoff pattern could (at least
approximately) be created by combining the
spikes obtained from different butterfly
spreads
Options, Futures, and Other Derivatives, 9th Edition,
Copyright © John C. Hull 2014
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