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# Trading Strategies Involving Options - PowerPoint PPT Presentation

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• 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.
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.
• 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 9.9 (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.
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.