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8/14/2019 Bm Fi6051 Wk6 Lecture
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Financial DerivativesFI6051
Finbarr MurphyDept. Accounting & FinanceUniversity of LimerickAutumn 2009
Week 5.1 Trading Strategies
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The following discussion considers the combiningof positions in two or more options contracts Where the contracts are written on the same underlying
asset
The primary effect of such options tradingstrategies is the creation of varied payoff profiles
For each of the options trading strategyconsidered the profit and loss profile will beillustrated
Options Trading Strategies
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A spread trading strategyinvolves taking aposition in two or more options of the same type That is, calls or puts
The next sections detail the four main spreadstrategies, i.e. Bull spreads
Bear spreads Butterfly spreads
Calender spreads
Spreads
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A bullspreadis created by going long a call witha given strike and shorta call with a higherstrike Both options have the same expiration date
Bull Spreads
K1 K2
K2- K1-(c1- c2)
-(c1- c2
)
Profit
Stock Price
Profit
K1
-c1
Stock Price
Profit
K2
c2
Stock Price
Profit
K1
-c1
Stock Price
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Now consider the payofffrom each of theoptions positions, and hence the payoff from thebull spread
The following table illustrates
Bull Spreads
Stock Price Range Payoff from LongCall
Payoff from ShortCall
Payoff from BullSpread
2KST
21 KSK T
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A bearspreadis created by going long a call witha given strike and short a call with a lowerstrike Both options have the same expiration date
Bear Spreads
K1 K2
-(K2 - K1)+(c1 - c2)
(c1- c2)
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Now consider the payoff from each of the optionspositions, and hence the payoff from the bearspread
The following table illustrates
Bear Spreads
Stock Price Range Payoff from LongCall
Payoff from ShortCall
Payoff from BearSpread
2KST
21 KSK T
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A butterfly spreadinvolves taking positions inthree options with differing strikes
Butterfly Spreads
K1 K2
-(c1+ c2 - 2c3)
K3
K2 - K1 - (c1+ c2 - 2c3)
K3
c3
Profit
Stock PriceK2
-c2
Profit
Stock PriceK1
-c1
Profit
Stock PriceK2
-c2
Profit
Stock PriceK1
-c1
Profit
Stock Price
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The following graph illustrates theprofit & lossprofile of the butterfly spread
Butterfly Spreads
K1 K2
-(c1+ c2 - 2c3)
K3
K2 - K1 - (c1+ c2 - 2c3)
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The following table illustrates
Note that the total payoffs in the final column
follow from noting that
Butterfly Spreads
Stock PriceRange
Payoff fromLong Call
(Low Strike)
Payoff fromLong Call
(High Strike)
Payoff fromShort Calls
(Inter Strikes)
Payoff fromButterfly
Spread
1KST
0T
SK
KST0KS
T
TSK
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The following graph illustrates theprofit & lossprofile of a straddle
Straddles
K
-(c1 + p1)
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A strip involves going long one call and two putswith the same strike price and expiration date
Now consider the payoff from each of the options
positions, and hence the payoff from the strip
Strips
Stock Price Range Payoff from LongCall
Payoff from LongPuts
Payoff from Strip
KST
KST>
0 ( )T
SK2
KST0KS
T
( )T
SK2
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A strap involves going long two calls and one putwith the same strike price and expiration date
Straps
Stock Price Range Payoff from LongCall
Payoff from LongPuts
Payoff from Strap
KST
KST>
0T
SK
( )KST 20( )KST 2
TSK
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A strangle involves going long a call and putoption with the same expiration and differentstrike prices
Now consider the payoff from each of the optionspositions, and hence the payoff from the strangle
Strangle
Stock Price Range Payoff from LongCall
Payoff from LongPuts
Payoff fromstrangle
1KST
21 KSK T
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Strangle
The following graph illustrates theprofit & lossprofile of a strangle
K1
-(c1 + p2)
K2
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