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Financial Engineering

Financial Engineering. Lecture 4. Option Strategies. Bullish Strategies Risk Reward Call purchase limited unlimited Synthetic long stock unlimited unlimited Bull spread limited limited Protective Put limited unlimited Bullish calendar spread limited unlimited

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Financial Engineering

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  1. Financial Engineering Lecture 4

  2. Option Strategies Bullish Strategies Risk Reward Call purchase limited unlimited Synthetic long stock unlimited unlimited Bull spread limited limited Protective Put limited unlimited Bullish calendar spread limited unlimited Covered call unlimited limited Naked put write unlimited limited

  3. Option Strategies Bearish Strategies Risk Reward Put purchase limited unlimited Synthetic Put limited unlimited Synthetic short sale unlimited unlimited Bear spread limited limited Covered put write unlimited limited Bearish calendar spread limited unlimited Naked call write unlimited limited

  4. Covered Call Long Stock, Short Call

  5. Covered Call Long Stock, Short Call Profit = S + call - P BE = P - call

  6. Protective Put Long Stock, Long Put

  7. Protective Put Long Stock, Long Put Profit = P - put - S

  8. Synthetic Long Put • Short Stock, Long Call

  9. Synthetic Long Put • Short Stock, Long Call

  10. Synthetic Short Call • Short Stock, Short Put

  11. Synthetic Short Call • Short Stock, Short Put

  12. Synthetic Stock • Short Put, Long Call

  13. Synthetic Stock • Short Put, Long Call

  14. Synthetic Stock • Short Put, Long Call

  15. Bull Spread • Long Call @ s1 s1 < s2 • Short Call @ s2 • Max Profit = s2 - s1 - c1 + c2 • Break Even = s2 - MP = s1 - c2 + c1

  16. Bull Spread Example Price = 32 Oct35C = 1 t=60days/365 Oct30C = 3 v = .24 Buy Oct30C = -3 Sell Oct35C = +1 Max Profit = 35-30-3+1 = 3 BE = 30-1+3 = 32 Net Debit = -3 + 1 = -2

  17. Bull Spread

  18. Bull Spread

  19. Bull Spread

  20. Bull Spread

  21. Bull Spread • Profit / Loss Diagram Table

  22. Bull Spread • Compute probability of bull spread • Example • Vt = .24 (60/365).5 = .097 • Prob (<32) = N[ln(32/32) /.097] = .5000 • Prob (>32) = 1 - .500 = .5000 • Max Profit = $300 • Max Loss = -$200 • at 50% odds, makes good sense

  23. Bull Spread

  24. Aggressive Bull Spread • s1 < P << s2 • Good probability, good profit potential

  25. Extremely Aggr. Bull Spread • P < s1 < s2 • Small Cost, high profit, low prob

  26. Least Aggr. Bull Spread • S1 < s2 < P • Low profit, high prob

  27. Put Bull Spread Long Put @ s1 s1 < s2 Short put @ s2 example (Credit Spread) Price = 55 Jan50P = 2 Jan60P = 7 Net Credit = p2 - p1 = + 7 - 2 = + 5 Break Even = S2 - credit = 60 - 5 = 55

  28. Put Bull Spread

  29. Put Bull Spread

  30. Put Bull Spread

  31. Call Bear Spread Short Call @ s1 s1 < s2 Long Call @ s2 credit spread

  32. Call Bear Spread Short Call @ s1 s1 < s2 Long Call @ s2 credit spread Example P = 55 Jan60C = 2 Jan50C = 7 Net Credit = 7 - 2 = 5 BE = 50 + 5 = 55

  33. Call Bear Spread Short Call @ s1 s1 < s2 Long Call @ s2 credit spread Example P = 55 Jan60C = 2 Jan50C = 7 Net Credit = 7 - 2 = 5 BE = 50 + 5 = 55

  34. Put Bear Spread Long Put @ s1 s1 > s2 Short Put @ s2 debit spread

  35. Put Bear Spread Long Put @ s1 s1 > s2 Short Put @ s2 debit spread Example P = 55 Jan50P = 2 Jan60P = 7 Net Debit = 7 - 2 = 5 BE = 60 - 5 = 55

  36. Put Bear Spread Long Put @ s1 s1 > s2 Short Put @ s2 debit spread Example P = 55 Jan50P = 2 Jan60P = 7 Net Debit = 7 - 2 = 5 BE = 60 - 5 = 55

  37. Call Bear vs. Put Bear +Credit spread - assignment risk ? What causes assignment -Large Credit = P well above lower strike Example: p = 59, Jan60C=1, Jan50C=9

  38. Bull Spread - Roll Down Long Stock, Long Call, Short 2 Calls Example Own stock @ $48 Price = 42 Oct40Call = 4 (buy) Oct45Call = 2 (sell 2) Net Credit = 0 BE = 44

  39. Bull Spread - Roll Down

  40. Bull Spread - Roll Down

  41. Bull Spread - Roll Down

  42. Bull Spread - Roll Down

  43. Bull Spread - Roll Down

  44. Bull Spread - Roll Down Price P/LSt P/L Sh C P/L Lg C Net P/L 35 -1300 +400 -400 -1300 38 -1000 +400 -400 -1000 40 -800 +400 -400 -800 42 -600 +400 -200 -400 44 -400 +400 0 0 45 -300 +400 +100 +200 48 0 -200 +400 +200 50 +200 -600 +600 +200

  45. Synthetic Covered CallBull spread If call is deep in the money and has no time to exp, a bull spread can be used to simulate a covered call. Example Price = 49 Sell Apr50C = 3 Buy Apr35C = 14

  46. Synthetic Covered CallBull spread

  47. Butterfly Spread A neutral position that combines both a bear spread and a bull spread Long call @ s1 s1 < s2 < s3 Short 2 calls @ s2 Long call @ s3 Example Price = 60 buy July50C = 12 1200 debit short2 July60C = 6 1200 credit buy July70C = 3 300 debit 300 Net Debit

  48. Butterfly Spread

  49. Butterfly Spread

  50. Butterfly Spread

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