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Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Trading Strategies Involving Options
Chapter 11
1
Strategies to be Considered
Bond plus option to create principal protected note
Stock plus option Two or more options of the same type
(a spread) Two or more options of different types
(a combination)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013 2
Principal Protected Note
Allows investor to take a risky position without risking any principal
Example: $1000 instrument consisting of 3-year zero-coupon bond with principal of
$1000 3-year at-the-money call option on a stock
portfolio currently worth $1000
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013 3
Principal Protected Notes continued
Viability depends on Level of dividends Level of interest rates Volatility of the portfolio
Variations on standard product Out of the money strike price Caps on investor return Knock outs, averaging features, etc
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013 4
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Positions in an Option & the Underlying (Figure 11.1, page 257)
Profit
STK
Profit
ST
K
Profit
ST
K
Profit
STK
(a) (b)
(c)
(d) 5
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bull Spread Using Calls(Figure 11.2, page 258)
K1 K2
Profit
ST
6
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bull Spread Using PutsFigure 11.3, page 259
K1 K2
Profit
ST
7
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bear Spread Using PutsFigure 11.4, page 260
K1 K2
Profit
ST
8
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bear Spread Using CallsFigure 11.5, page 261
K1 K2
Profit
ST
9
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Box Spread
A combination of a bull call spread and a bear put spread
If all options are European a box spread is worth the present value of the difference between the strike prices
If they are American this is not necessarily so (see Business Snapshot 11.1)
10
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Butterfly Spread Using CallsFigure 11.6, page 263
K1 K3
Profit
STK2
11
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Butterfly Spread Using PutsFigure 11.7, page 264
K1 K3
Profit
STK2
12
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Calendar Spread Using CallsFigure 11.8, page 265
Profit
STK
13
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Calendar Spread Using PutsFigure 11.9, page 265
Profit
STK
14
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
A Straddle CombinationFigure 11.10, page 266
Profit
STK
15
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Strip & StrapFigure 11.11, page 267
Profit
K ST
Profit
K ST
Strip Strap
16
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
A Strangle CombinationFigure 11.12, page 268
K1 K2
Profit
ST
17
Other Payoff Patterns
When the strike prices are close together a butterfly spread provides a payoff consisting of a small “spike”
If options with all strike prices were available any payoff pattern could (at least approximately) be created by combining the spikes obtained from different butterfly spreads
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013 18
