Trading Strategies Involving Options

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## Trading Strategies Involving Options

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**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.**Figure 9.7 (p.225)**Profit X1 X2 X3 ST Butterfly Spread Using Puts**Figure 9.6 (p.223)**Profit X1 X2 X3 ST Butterfly Spread Using Calls**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**• 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.**Figure 9.8 (p. 225)**Profit ST X Calendar Spread Using Calls**Calendar Spread Using Puts**• Figure 9.9 (p.226) Profit ST X**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.**Figure 9.10 (p.227)**Profit X ST A Straddle Combination**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?**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.**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**• Figure 9.11 (p. 229) Profit Profit X ST X ST Strip Strap**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.**Figure 9.12 (p. 229)**Profit X1 X2 ST A Strangle Combination**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?**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?