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Option StrategiesOption Strategies
DefinitionsDefinitions
• In the money
An option is in-the-money when there would be
profit in exercising it immediately
• Out of the money
Out-of-the-money when it would be worthless if
exercised immediately.
DefinitionsDefinitions
The option price, or premium, can be considered as the sum of two specific elements: intrinsic value and time value
The intrinsic value of an option is the amount an option holder can realise by exercising the option immediately. Intrinsic value is always positive or zero. An out-of-the-money option has zero intrinsic value
DefinitionsDefinitions
Bearish Market:
Market in which prices are generally declining and the
underlying sentiment reinforces that decline.
Bullish Market:
Rising market, or a market in which further price increases are expected , due to strong demand.
Stagnated Market.
Market in which neither increases or decreases are to be expected
DefinitionsDefinitions
• The time value of an option is the value over and above intrinsic value that the market places on the option. It can be considered as the value of the continuing exposure to the movement in the underlying product price that the option provides. The price that the market puts on this time value depends on a number of factors: time to expiry, volatility of the underlying product price, risk free interest rates and expected dividends.
Strategies related to Strategies related to future market movement future market movement
Stock Price Up
Stock Price Down
IncreasingConfidence level
DecreasingConfidence level
Long Put
Long Call
Bull CallSpreads
Bear CallSpreads
Bull PutSpreads
Bear PutSpreads
CoveredCall Writing
Short Put
Short Call
Protective Short stock
Short Stock
Long Stock
SyntheticLong Stock
SyntheticShort Stock
Strategies related to Strategies related to future market Volatility future market Volatility IncreasingVolatilities
DecreasingVolatilities
Long Strangle Short Strangle
Long Straddle Short Straddle
Short Butterfly Long Butterfly
Ratio Put Back Spread Ratio Put Spread
Ratio Call Back Spread Ratio Call Spread
Option StrategiesOption Strategies
Single Option Strategy:
• Short Call
• Short Put
• Long Call
• Long Put
Short CallShort Call
When to Use:
If you firmly believe the market is not going up. Sell out-of-the-money (higher strike) options if you are only some what convinced; sell at-the-money options if you are very confident the market will stagnate or fall. If you doubt market will stagnate, sell in-the-money options for maximum profit
An option strategy whereby a person sells (shorts) a Call option-100
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Short CallShort Call
Profit: Limited to the premium received from selling the call.
Loss: Unlimited in a rising market.
Break-even: reached when the underlying rises above the strike price, by the same amount as the premium received from selling the call
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Short PutShort Put
When to use:
If you firmly believe the market is not going down. Sell out-of-the-money (lower strike) options if you are only somewhat convinced; sell at-the-money options if you are very confident the market will stagnate or rise. If you doubt market will stagnate, sell in-the-money options for maximum profit.
An option strategy whereby a person sells (shorts) a put option
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Short PutShort Put
Profit possibilities:
Limited to premium received
Loss possibilities:
Unlimited in a falling market
Break-even:
When the price underlying falls below the strike price by the same amount as the premium
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Long CallLong Call
When to Use:
When you are very bullish on the market. The more bullish you are, the more out-of-the-money (higher) should be the option you buy. No other positions gives you as much leverage advantage in a rising market ( with limited downside risk).
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t Buy a call with an exercise price of (A).
A
Long CallLong CallProfit possibilities:
Unlimited in a rising market
Loss possibilities
Limited to the initial premium.
Break-even
Reached when the underlying rises above the strike price, by the same amount as the premium paid to establish the position.
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Long PutLong Put
When to use:
When you are very bearish on market. The more bearish you are, the more out-of-the-money (lower) should be the option you buy. No other position gives you as much leveraged advantage in a falling market (with limited upside risk).
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t Buy a put (A).
A
Long PutLong PutProfit possibilities
Unlimited in a falling market
Loss possibilities
Limited to the initial premium paid
Break-even
Reached when the underlying falls below the strike price A by the same amount as the premium paid to establish the position
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Option StrategiesOption Strategies
General Combination Strategies:
– Long Straddle
– Short Straddle
– Long Strangle
– Short Strangle
Long StraddleLong Straddle
When to use:
If market is near A and you expect it to start moving but are not sure which way. Especially good position if market has been quiet, then starts to zigzag sharply, signalling potential eruption
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fit Buy call, buy put of the same strike price and month
Long StraddleLong Straddle
Profit possibilities : Unlimited for an increase or decrease in the underlying.
Loss possibilities : Limited to the premium paid in establishing the position. Will be greatest if the underlying is at strike A, at expiry.
Break-even: Reached if the underlying rises or falls from strike A by the same amount as the premium cost of establishing the position.
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A
Short StraddleShort Straddle
When to use: If market is near A and you expect market is stagnating. Because you are short options, you reap profits as they decay - as long as market remains near A
A call option and a put option are sold with the same strike price A
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Short StraddleShort Straddle
Profit possibilities : Limited to the credit received from establishing the position. Highest if the market settles at A.
Loss possibilities : Unlimited for both an increase or decrease in the underlying.
Break-even: Reached if the underlying rises or falls from strike A by the same amount as the premium received from establishing the position
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Long StrangleLong Strangle
When to use: If market is within or near A-B range and has been stagnant. If market explodes either way, you make money; if market continues to stagnate, you lose less than with a long straddle.
Buy a put (A), buy a call at higher strike (B).
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A B
Long StrangleLong Strangle
Profit possibilities: unlimited although a substantial directional movement is necessary to yield a profit for both a rise or fall in the underlying.
Loss possibilities: Occurs if the market is static; limited to the premium paid in establishing the position.
Break-even: Occurs if the market rises above the higher strike price at B by an amount equal to the cost of establishing the position, or if the market falls below the lower strike price at A by the amount equal to the cost of establishing the position
.
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A B
Short StrangleShort Strangle
Sell a put (A), sell call at higher strike (B)
When to use:
If market is within or near A-B range and, though active, is quieting down. If market goes into stagnation, you make money; if it continues to be active, you have a bit less risk than with a short straddle
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Short StrangleShort Strangle
Profit possibilities : Limited to the premium received. Will be highest if the underlying remains within the market level A-B.
Loss possibilities : Unlimited for a sharp move in the underlying in either direction.
Break-even: reached if the underlying falls below strike A or rises above strike B by the same amount as the premium received in establishing the position
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Option StrategiesOption StrategiesVertical Spread
This strategy involves buying and selling option contracts of the same type, same number, same expiry month but different strike prices.
If the spread portfolio consists of buying lower strike price options and selling higher strike price options, it is referred to as a Bull Spread. Following the same logic, if the spread portfolio consists of buying higher strike price options and selling lower strike price options, it is referred to as a Bear Spread.
– Bull Spread
– Bear Spread
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Bull Call SpreadBull Call Spread
Buy a call (A), sell call at higher strike (B).
When to use: If you think the market will go up somewhat or at least is a bit more likely to rise than fall. Good position if you want to be in the market but are unsure of bullish expectations.
A
B
Bull Call SpreadBull Call Spread
Profit possibilities: Limited to the difference between the two strike prices minus the net premium paid
Loss possibilities: Net premium paid
Break-even: Lower strike price plus net premium paid
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Bear SpreadBear Spread
When to use:
If you think the market will fall somewhat or at least is a bit more likely to fall than rise.
Sell lower strike price call, buy higher strike price call of the same month
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Bear SpreadBear Spread
Profit possibilities:When the stock price is below the break-even point, Limited to the net premium received
Loss possibilities: The difference between the two strike prices minus the net premium received
Break-even: Lower strike price plus net premium received
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