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Derivatives Trading Strategies
Professor André Farber Solvay Brussels School of Economics and Management Université Libre de Bruxelles
September 14, 2005 Derivatives 09 Strategies |2
Trading strategies
1. A single option and a stock: covered call, protective put • Covered call: S-C • Protective put: S+P
2. Spreads: bull, bear, butterfly, calendar • Bull: +C(X1) – C(X2) X1<X2 • Bear: +C(X1) – C(X2) X1>X2 • Butterfly: +C(X1) + C(X3) – 2C(X2) X1<X2<X3 • Calendar: +C(T1)-C(T2) T1>T2
3. Combinations: straddle, strips and straps, strangle • Straddle: +C+P • Strip: +C + 2P • Strap: +2C+P • Strangle: +C(X2)+P(X1) X1<X2
September 14, 2005 Derivatives 09 Strategies |3
Analyzing a strategy
• Initial cost • Maximum profit: limited, unlimited • Maximum loss: limited, unlimited • Breakeven price: when do you recover initial price • Standstill return: quid if stock price does not change? • Market outlook: bearish, neutral, bullish • Risk posture
September 14, 2005 Derivatives 09 Strategies |4
Covered Call Maturity
Covered call Price Delta
Stock 1 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 -1 63.37 0.55Call 1050 0.25 0 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 0 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Covered call 936.63 0.45
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Profit
Stock Price
Immediate
At maturity
September 14, 2005 Derivatives 09 Strategies |5
Protective Put Maturity Prot.put Price Delta
Stock 1 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 0 63.37 0.55Call 1050 0.25 0 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 1 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Prot.put 1055.90 0.55
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September 14, 2005
Portfolio insurance
• Objective: to replicate a protective put option strategy without buying options. 1. Set investment horizon 2. Specify floor: strike price of protective put
• Consider a portfolio with a protective put: • Value of portfolio V • Value of underlying assets S • Value of put option P
• Note: DeltaPut <0
Derivatives 09 Strategies |6
V S P= +
(1 )Put PutV S Delta S Delta SΔ = Δ + Δ = + Δ
September 14, 2005
Synthetic put option protection
Derivatives 09 Strategies |7
Consider now a portfolio:
Same total value V (=S+P) Asset allocation: (1 + DeltaPut ) shares
Riskless investment M
(1 )(1 )
Put
Put
V Delta S MV Delta S= + +
Δ = + Δ
Replicates the protective put strategy Requires dynamic adjustment
September 14, 2005 Derivatives 09 Strategies |8
Bull Call Spread
MaturityBull spread
Price DeltaStock 0 1,000.00 1.00Call 950 0.25 1 91.02 0.68Call 1000 0.25 0 63.37 0.55Call 1050 0.25 -1 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 0 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Bull spread 48.76 0.26
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September 14, 2005 Derivatives 09 Strategies |9
Bear Call Spread
MaturityBear
spread Price DeltaStock 0 1,000.00 1.00Call 950 0.25 -1 91.02 0.68Call 1000 0.25 0 63.37 0.55Call 1050 0.25 1 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 0 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Bear spread -48.76 (0.26)
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September 14, 2005 Derivatives 09 Strategies |10
Butterfly
Maturity Butterfly spreadPrice DeltaStock 0 1,000.00 1.00Call 950 0.25 1 91.02 0.68Call 1000 0.25 -2 63.37 0.55Call 1050 0.25 1 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 0 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Butterfly spread 6.54 0.00
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September 14, 2005 Derivatives 09 Strategies |11
Straddle
Maturity Straddle Price DeltaStock 0 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 1 63.37 0.55Call 1050 0.25 0 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 1 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Straddle 119.27 0.10
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September 14, 2005 Derivatives 09 Strategies |12
Strip
Maturity Strip Price DeltaStock 0 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 1 63.37 0.55Call 1050 0.25 0 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 2 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Strip 175.17 (0.35)
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September 14, 2005 Derivatives 09 Strategies |13
Strap Maturity Strap Price Delta
Stock 0 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 2 63.37 0.55Call 1050 0.25 0 42.26 0.42Put 950 0.25 0 33.92 -0.32Put 1000 0.25 1 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Strap 182.64 0.65
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September 14, 2005 Derivatives 09 Strategies |14
Strangle Maturity Strangle Price Delta
Stock 0 1,000.00 1.00Call 950 0.25 0 91.02 0.68Call 1000 0.25 0 63.37 0.55Call 1050 0.25 1 42.26 0.42Put 950 0.25 1 33.92 -0.32Put 1000 0.25 0 55.90 -0.45Put 1050 0.25 0 84.42 -0.58Strangle 76.19 0.10
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