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Week 5 (chapter 12): Trading strategies involving options (Options trading…
Week 5 (chapter 12): Trading strategies involving options
Options trading strategies
Options can be combined with each other and with other securities to produce a large variety of payoffs
Used for
Speculative: take specific positions on the basis of some particular information
Risk management: re- engineer the payoffs from some existing position
3 types
Combinations (calls + puts)
Strips
Strangles
Straddles
Straps
Covered call, protective put, collar (underlying + options)
Spreads (calls + calls or puts + puts)
Bear spreads
Butterfly spreads
Bull spreads
Combinations
Straddle
definition: buying/ selling both a call and a put with the same features
same features
Underlying stock
Exercise (strike) price
Expiration date
Long Straddle
Motivation for buying a straddle: expectation of
large share price movements
in either direction
Underlying stock remains
stable
=>
loss
on the straddle
Short Straddle
Seller of a straddle: betting
against
large price movements
Share price
moves significantly
in either direction =>
loss
on the straddle
Strangle
to reduce downside risk
(how?): stock price ends up at a central value is less with a strangle
Short strangle
sell a call at a higher exercise price (K2) and a put at a lower exercise price (K1) (same expiry date), where
K2 > K1
Long strangle
buy a call at a higher exercise price (K2) and a put at a lower exercise price (K1) (same expiry date), where
K2 > K1
Strips and Straps
Strip
a share price is more likely to
decrease
long strip: buy one ATM call and two ATM puts
short strip
Strap
a share price is more likely to
increase
long strap: buy two ATM calls and one ATM put
short strap