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Trading Strategies Involving Options. Butterfly Spread.

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butterfly spread
Butterfly Spread
  • A butterfly spread involves positions in options with three different strike prices. It can be created by buying two options with low and high strike prices and selling two options with a strike price halfway between low and high strike prices.
  • It leads to a small profit if futures price stay close to selling strike price but makes small loss if there is a significant futures price move in either direction.
slide5
Call options on a stock are available with strike prices of $15, $17.5, and $20 and expiration dates in three months. Their prices are $4, $2, and $0.5, respectively. Explain how the options can be used to create a butterfly spread. Construct a table showing how profit varies with stock price for the butterfly spread.
calendar spread
Calendar Spread
  • A calendar spread can be created by selling a call option with a certain strike price and buying a longer maturity call option with the same strike price.
calendar spread using puts
Calendar Spread Using Puts
  • Figure 9.9 (p.226)

Profit

ST

X

combinations
Combinations
  • A combination is a strategy that involves taking a position in both calls and puts on the same stock.
  • There are different types of combinations
    • Straddle: Can be created by buying both a put and a call with a strike price close to current selling price. A straddle is appropriate strategy if the investor is expecting a large move in a stock price in either direction. This is also called as a bottom straddle or straddle purchase.
problem
Problem
  • Consider an investor who feels that the price of a certain stock, currently, valued at $69 by the market, will move significantly in the next three months. The investor could create a straddle by buying a put and a call with a strike price of $70 and an expiration date in three months. Suppose that the call costs $4 and the put costs $3. What is the pattern of profit from the straddle?
combinations1
Combinations
  • Similarly, a top straddle can be created by selling a call and a put with the same exercise price and expiration date.
    • This strategy results in profit if the stock price on the expiration date is close to the strike price.
    • A large move in either direction results in significant loss.
combinations2
Combinations
  • Strip: A strip strategy includes a long position in one call and two puts with the same strike price and expiration date.
    • In a strip, investor believes that there is more likelihood of price to decrease than increase.
  • Strap: A strap includes a long position in two calls and one put with same strike price and expiration date.
    • Investor is betting a increase in the stock price more likely than a decrease.
strip strap
Strip & Strap
  • Figure 9.11 (p. 229)

Profit

Profit

X

ST

X

ST

Strip

Strap

combinations3
Combinations
  • Strangles: Includes a long in call and put with the same expiration date and different strike price.
    • This is similar to strangle strategy. The use of two different strike price reduces the downward risks.
payoff from a straddle
Payoff from a straddle
  • A call with a strike price of $60 costs $6. A put with the same strike price and expiration date costs $4. Construct a table that shows the profit from a straddle. For what range of stock prices would the straddle lead to a loss?
slide18
Three put options on a stock have the same expiration date and strike prices of $55, $60, and $65. The market prices are $3, $5, and $8, respectively. Explain how a butterfly spread can be created. Construct a table showing the profit from the strategy. For what range of stock prices would the butterfly spread lead to a loss?