Chapter 11
Trading Strategies Involving
Options
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
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, 8th Edition,
Copyright © John C. Hull 2012
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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, 8th Edition,
Copyright © John C. Hull 2012
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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, 8th Edition,
Copyright © John C. Hull 2012
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Positions in an Option & the Underlying
(Figure 11.1, page 237)
Profit
Profit
K
K
ST
ST
(a)
(b)
Profit
Profit
K
ST
(c)
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
K
ST
(d)
5
Bull Spread Using Calls
(Figure 11.2, page 238)
Profit
ST
K1
K2
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
6
Bull Spread Using Puts
Figure 11.3, page 239
Profit
K1
K2
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
ST
7
Bear Spread Using Puts
Figure 11.4, page 240
Profit
K1
K2
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
ST
8
Bear Spread Using Calls
Figure 11.5, page 241
Profit
K1
K2
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
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, 8th Edition,
Copyright © John C. Hull 2012
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Butterfly Spread Using Calls
Figure 11.6, page 242
Profit
K1
K2
K3
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
ST
11
Butterfly Spread Using Puts
Figure 11.7, page 243
Profit
K1
K2
K3
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
ST
12
Calendar Spread Using Calls
Figure 11.8, page 245
Profit
ST
K
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
13
Calendar Spread Using Puts
Figure 11.9, page 246
Profit
ST
K
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
14
A Straddle Combination
Figure 11.10, page 246
Profit
K
Options, Futures, and Other Derivatives, 8th Edition,
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ST
15
Strip & Strap
Figure 11.11, page 248
Profit
Profit
K
Strip
ST
K
ST
Strap
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
16
A Strangle Combination
Figure 11.12, page 249
Profit
K1
K2
ST
Options, Futures, and Other Derivatives, 8th Edition,
Copyright © John C. Hull 2012
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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, 8th Edition,
Copyright © John C. Hull 2012
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