© All Rights Reserved

Просмотров: 97

© All Rights Reserved

- CFA Level I- Financial Reporting and Analysis- SMG.pdf
- R41_Valuation_of_Contingent_Claims_IFT_Notes.pdf
- R40_Pricing_and_Valuation_of_Forward_Commitments_IFT_Notes.pdf
- Financial Analyst CFA Study Notes: Quantitative Methods Level 1
- CFA Level 1 Ethical Standards Notes
- Instrumentos Financieros Para Cobertura Del Riesgo- Parte I
- R42_Derivative_Strategies_Q_Bank.pdf
- PS 2 Solution
- CFA Level 1 Corporate Finance E book - Part 1.pdf
- R28-Financial-Analysis-Techniques-IFT-Notes.pdf
- R37_Valuation_and_Analysis_Q_Bank.pdf
- ICAEW Financial Management
- Fixed Income > YCM 2001 - Interest Rate Derivatives
- David Bukey - The S&P Witch Project
- i Cici Trading Conditions
- 2012-06_CFA_L2_100_forecast
- Simple Options Trading
- Intro to Options Webinar Notes
- R44_Publicly_Traded_Real_Estate_Securities_Q_Bank.pdf
- R47_The_Porfolio_Management_Process_and_the_IPS_Q_Bank.pdf

Вы находитесь на странице: 1из 24

1. Introduction ............................................................................................................................. 2

2. Changing Risk Exposures with Swaps, Futures, and Forwards .............................................. 2

2.1. Interest Rate Swap/Futures Examples .............................................................................. 2

2.2. Currency Swap/Futures Examples ................................................................................... 2

2.3. Equity Swaps/Futures Examples ...................................................................................... 3

3. Position Equivalencies ............................................................................................................. 5

3.1. Synthetic Long Asset ........................................................................................................... 5

3.2. Synthetic Short Asset ........................................................................................................... 5

3.3. Synthetic Assets with Futures/Forwards .............................................................................. 6

3.4. Synthetic Put ........................................................................................................................ 6

3.5. Synthetic Call ....................................................................................................................... 7

4. Covered Calls and Protective Puts........................................................................................... 8

4.1. Investment Objectives of Covered Calls.............................................................................. 8

4.4. Writing Cash-Secured Puts ................................................................................................ 12

5. Spreads and Combinations .................................................................................................... 13

5.1. Bull Spreads and Bear Spreads .......................................................................................... 14

6. Investment Objectives and Strategy Selection ...................................................................... 17

6.1. The Necessity of Setting an Objective ............................................................................... 18

This document should be read in conjunction with the corresponding reading in the 2017 Level II

CFA Program curriculum. Some of the graphs, charts, tables, examples, and figures are

copyright 2016, CFA Institute. Reproduced and republished with permission from CFA Institute.

All rights reserved.

Required disclaimer: CFA Institute does not endorse, promote, or warrant the accuracy or

quality of the products or services offered by IFT. CFA Institute, CFA, and Chartered

Financial Analyst are trademarks owned by CFA Institute.

R42 Derivatives Strategies IFT Notes

1. Introduction

In this reading we will cover:

The use of swaps, futures, and forwards to modify risk exposure of an existing position

Equivalencies of certain positions

Covered calls and protective puts

Common option strategies

Applications of derivatives by money managers

To manage the risk exposures of portfolios, financial managers use various derivative

instruments.

Interest rate swaps and futures are interest-sensitive instruments that can be used to modify the

risk and return of a fixed-income portfolio.

The use of an interest rate swap to manage the interest rate risk of a fixed income portfolio is

best understood through a simple example. Say we are responsible for a fixed income portfolio

containing $100 million of fixed-rate US Treasury bond. The average duration of these bonds is

six years. We believe that interest rates are likely to rise in the near term which will negatively

impact value. We want to reduce the duration of the portfolio without selling any securities.

This can be accomplished by entering a pay-fixed, receive-floating interest rate swap with a

duration that is less than the duration of the existing portfolio. If interest rates do rise, the value

of the fixed income portfolio will decline but the value of the pay-fixed, receive-floating interest

swap will rise. Hence the interest rate swap allows us to reduce exposure to changes in interest

rates.

The duration of a fixed income portfolio can also be modified using interest rate futures.

Consider the same $100 million fixed income portfolio with a duration of six. The interest rate

sensitivity can be reduced by going short on futures contracts where the underling is a bond. If

interest rates rise the value of the original fixed income portfolio will fall but this will be

compensated by an increase in value of the short position in the bond futures contract.

What can be accomplished with futures contracts can also be done with forward contracts.

Forward contracts are over-the-counter (OTC) instruments. They can be customized but face

counterparty risk. Futures contracts are standardized and there is no counterparty risk.

A currency swap can be used to reduce borrowing cost. Say we represent a US-based entity

which wants to expand in Europe. We need funding in Europe but our cost of borrowing in euros

is much higher than the cost of borrowing in dollars. We can address this challenge by borrowing

R42 Derivatives Strategies IFT Notes

in the US and simultaneously entering a dollar-euro currency swap where we make interest

payments in euro and receive interest payments in dollars.

Currency swaps were covered in Pricing and Valuation of Forward Commitments. However, as

a quick recap, the currency swap described here involves the following cash flows:

At Time 0, we give the dollar notional amount and receive the euro notional amount to

the swap counterparty.

During the life of the swap contract we make interest payments in euro and receive

interest payments in dollars.

At the end of the contract we receive the dollar notional amount and pay the euro notional

amount.

With the dollar-based loan we receive the notional amount (principal) at Time 0 and make

interest payments over the life of the loan. The principal is returned at end of the loan period.

The combined effect of the loan and the currency swap is shown in the table below:

Initiation Receive notional Pay notional amount in dollars and Receive notional

amount in dollars receive euros amount in euros

Life of swap Pay interest in Receive interest in dollars Pay interest in

and loan dollars Pay interest in euros euros

Termination Pay back notional Receive notional amount in dollars; Return notional

amount in dollars pay notional amount in euros amount in euros

The combined effect of the dollar based loan and the currency swap is that we have effectively

borrowed in euros at a relatively low rate.

Note that a currency swap is different from interest rate swaps in two ways:

1. With a currency swap, we work with two different interest rates one for each currency.

2. In an interest rate swap, the notional amount is not exchanged at the start and end of the

contract. A currency swap typically involves the exchange of notional principal at the

start and end of the contract.

Foreign currency futures can be used to manage currency risk. Say we represent a US-based

company and have suppliers in Europe. We have a 25 million liability due to be paid in 6

months. Our risk is that the euro will appreciate relative to the dollar. This risk can be mitigated

if we buy euros (or sell dollars) in the futures market. If the futures contract size is 125,000, we

will need 25,000,000/125,000 = 200 contracts.

An equity swap can be used to manage equity market risk. This is best understood through an

example: we manage a large portfolio and want to reduce our equity exposure by $100 million

over the next six months. To accomplish this objective, we can execute a six-month equity swap

with the following terms: at the end of six months we pay the equity return and receive six month

Libor which is currently 0.50%. The following exhibit from the curriculum shows the cash

R42 Derivatives Strategies IFT Notes

flows from the equity swap if the portfolio rises or falls by 1%.

Pay: $100 million 1% = ($1,000,000)

Receive: $100 million 0.50% 0.50 = 250,000 Libor six-month return on $100 mil.

Net payment = ($750,000)

Scenario 2: Equity portfolio declines 1%

Pay: $100 million 1% = $1,000,000 (*)

Receive: $100 million 0.50% 0.50 = 250,000 Libor six-month return on $100 mil.

Net receipt = $1,250,000

(*) Here we need to pay the equity return. The equity index is down by 1% so we pay a

negative number. Paying -1,000,000 means receiving 1,000,000. Hence the amount is shown as a

positive number.

The table below shows the overall impact considering both the $100 million equity portfolio and

the equity swap.

Equity up by 1% Up by 100,000 Net payment of 750,000 +250,000

Equity down by 1% Down by 100,000 Net receipt of 1,250,000 +250,000

In either case the gain is $250,000 which is the interest amount associated with the Libor rate of

0.50% over a six-month period. Hence the equity swap effectively removed the market risk of

the $100 million equity portfolio over the six-month period.

Stock index futures can also be used to manage equity market index. Specifically, a long equity

position can be hedged by selling stock index futures contracts. Consider a $100 million index

fund which tracks the S&P 500. We want to hedge our market exposure over the next month and

have access to S&P 500 stock index futures contract which is standardized as $250 times the

index level. The current index level is 2,000. To hedge our equity exposure, we can sell

100,000,000 / (250 x 200) = 200 contracts. If the index goes up by 1% (an increase of 20 points

from 2,000 to 2,020) the value of our portfolio increases by $1 million. At the same time the loss

on our short position in stock index futures contract is 20 points x $250 per point x 200 contracts

= $1,000,000. If the index goes down by 1%, the value of the portfolio decreases by $1 million

but this is balanced by the increase in the short stock index futures contract. Hence no matter

what happens to the market over the next month, the equity risk is completely hedged.

The interest rate risk of fixed income portfolio can be reduced by entering a pay-fixed,

received floating interest rate swap. The duration of the swap should be less than the

duration of the fixed income portfolio.

The interest rate risk of fixed income portfolio can be reduced by selling bond futures.

A currency swap can be used to reduce the cost of borrowing in a foreign currency. A

currency swap generally involves the exchange of principal at the start and end of the

contract.

R42 Derivatives Strategies IFT Notes

Equity swaps can be used reduce equity market exposure.

Equity futures contracts can be used reduce equity market exposure.

3. Position Equivalencies

In this section we will outline how certain combinations of derivatives are equivalent to other

assets/portfolios.

A long call and a short put synthetically replicate a long position in the underlying, called a

synthetic long position. This can be demonstrated by looking at the payoffs associated with two

different alternatives:

1) Buy a call and write a put. Both options have the same expiration date and the same exercise

price of $50.

2) Buy a stock for $50.

Alternative 1: Long call, short put

Long call payoff 0 0 0 0 10 30 50

Short put payoff 50 30 10 0 0 0 0

Alternative 1 payoff 50 30 10 0 10 30 50

Alternative 2: Long stock at 50

Alternative 2 payoff 50 30 10 0 10 30 50

The table above shows that payoff for both alternatives is the same. Hence we can conclude that:

where the exercise price of the call = exercise price of the put = initial price of the underlying

stock.

A synthetic short position can be replicated by a combination of a long put and a short call with

the same exercise price and expiration dates. This can be demonstrated by looking at the payoffs

associated with two different alternatives:

1) Go long a put and short a call with strike price of $50.

2) Short sell a stock for $50.

Alternative 1: Long put, short call

Long put payoff 50 30 0 0 0 0

R42 Derivatives Strategies IFT Notes

Alternative 1 Payoff 50 30 0 -10 -30 -50

Alternative 2: Short Stock at 50

Alternative 2 Payoff 50 30 0 -10 -30 -50

The table above shows that payoff for both alternatives is the same. Hence we can conclude that:

where the exercise price of the call = exercise price of the put = initial price of the underlying

stock.

Futures or forward contracts are used to eliminate future price risk. Suppose an investor wants to

sell his dividend-paying stock in the future. To lock the selling price, he might enter a forward or

futures contract. The price is ascertained today, and at a future date he will deliver the shares in

exchange for cash thereby removing price risk. This investment should earn the risk-free rate,

because both the initial and future prices are known.

Long stock + Short futures = Risk-free rate, or Stock Futures = Risk-free rate.

A synthetic long position can be created by investing in the risk-free asset and a long futures

position:

A synthetic put can be created by combining a short stock position with a long call. This can be

demonstrated by looking at the payoffs associated with two differ alternatives:

3) Go long a put with a strike price of 50.

4) Short sell a stock at $50 and go long a call with a strike price of 50.

Alternative 1: Long 50-strike put

Alternative 1 payoff 50 30 0 0 0 0

Alternative 2: Short Stock at 50; Long 50-strike call

Short stock payoff 50 30 0 -10 -30 -50

Long call payoff 0 0 0 10 30 50

Alternative 2 payoff 50 30 0 0 0 0

R42 Derivatives Strategies IFT Notes

The table above shows that payoff for both alternatives is the same. Hence we can conclude that:

A synthetic call can be replicated from a long stock position combined with a long put. This can

be demonstrated by looking at the payoffs associated with two differ alternatives:

1) Go long a call with a strike price of 50.

2) Long a stock at $50 and go long a put with a strike price of 50.

Alternative 1: Long call

Alternative 1 payoff 0 0 0 10 30 50

Alternative 2: Long Stock and long put

Long stock payoff -50 -30 0 10 30 50

Put payoff 50 30 0 0 0 0

Alternative 2 payoff 0 0 0 10 30 50

The table above shows that payoff for both alternatives is the same. Hence we can conclude that:

As with forward and futures currency contracts, currency options can be used to hedge currency

risk. However, there are some differences which are important to understand:

With forward and futures contracts there is no premium or upfront cost.

Currency options require the payment of a premium.

With forward and futures contracts the exchange rate is locked in so there is no benefit

even if the exchange rate movement is favourable.

With currency options the payoff is one sided. The purchaser of the option is protected

against an adverse movement in the exchange rate but benefits if there is a favourable

movement in the exchange rate.

The equivalency relationship with respect to currency options is the following: An X/Y call

option is identical to a Y/X put with the same expiration and exercise price, where X and Y are

two different currencies and X/Y is the currency exchange rate with Y as the base currency.

Long stock = Long call + Short put

Short stock = Long put + Short call

Risk-free rate = Long Stock + Short Futures

Long stock = Risk-free rate + Futures.

R42 Derivatives Strategies IFT Notes

Long call = Long stock + Long put

Currency X/Y call = Currency X/Y put

Covered call: A covered call is an option strategy in which one who own a stock, sells a call

option on that stock. It is known as a covered call because the short call position is covered by

owning the underlying stock. Hence: Covered Call = Long Stock + Short Call.

Protective put: A protective put is a long position in an asset and a long position in a put option

on that asset. It is known as a protective put, because the put provides protection against loss in

value of the underlying asset. Hence: Protective Put = Long Stock + Long Put.

Consider Exhibit A showing the premium for options on IFT stock which currently sells for $16.

Calls Exercise Puts

SEP OCT NOV Price SEP OCT NOV

1.64 3.00 3.44 15 0.65 1.00 1.46

0.94 2.00 2.90 16 1.14 1.50 1.96

0.51 1.00 1.44 18 1.76 2.00 2.59

With respect to terminology, when we say IFT October 16 call sells for 2.00, the 16 refers to

the exercise price.

Income generation

Improving on the market

Target price realization

Income Generation

The most common reason for writing covered calls is that it provides an additional source of

income in the form of the option premium. However, this income comes at a cost. If the stock

price rises above the exercise price the call writer needs to make a payment of (S X) to the call

buyer.

Scenario: Suppose a stock is trading at $16. An investor writes a SEP 18 call and collects the

premium of $0.51. This represents income for the investor. If the stock price increases from $16

to $18 the investor benefits. However, any stock appreciation above the strike price of $18 does

not benefit the investor. The gain in stock price is cancelled out by what the investor owes on the

short call position.

R42 Derivatives Strategies IFT Notes

If an investor has decided to sell a stock, he can use a covered call to effectively receive more

than the current market price of the stock.

Scenario: Using the data in Exhibit A, the IFT stock is at $16.00 and OCT 15 calls sell for 3.00.

An investor who has decided to sell IFT can sell OCT 15 options. He will receive $3 when he

writes the option and $15 when the option is exercised. Overall hell effectively receive $3 + $15

= $18 for the stock which is better than the market price of $16.

A third popular use of covered calls is a hybrid of the first two objectives. Here investors write

calls with an exercise price near the target price for the stock.

Scenario: Suppose the IFT stock is trading at $15.80 but its target price is $16.00. An investor

might choose to write SEP 16 calls and receive a premium of 0.94 (from Exhibit A). If the stock

rises above 16 in a month, the stock will be sold at its target price. Through this strategy the

investor sells the stock at the target price and pockets the premium.

there is a risk that the stock price may fall, resulting in an opportunity loss relative to the

outright sale of the stock.

an opportunity loss also occurs if the stock rises sharply above the exercise price and it is

sold at lower-than-market price.

S0 = Stock price when option position opened

ST = Stock price at option expiration

X = Option exercise price

c0 = Call premium received or paid

The following is the summary of profit and loss relationships for a covered call strategy:

Maximum gain = (X S0) + c0

Maximum loss = S0 c0

Breakeven point = S0 c0

Expiration value = ST Max [(ST X),0]

Profit at expiration = ST Max [(ST X),0] + c0 S0

Taking the example of the IFT, currently = S0 = 16.00, writing the IFT OCT 18 for 1.00, X=

18.00, c0 = 1.00. If ST = 16.00 then:

Max gain =

R42 Derivatives Strategies IFT Notes

Max loss =

Breakeven point =

Profit at expiration = if ST = 16.00

Profit/Loss $

Max Gain 3

0 15 18 ST

B.E.

S0 = Stock price when option position opened = 25.00

X = Option exercise price = 30.00

ST = Stock price at option expiration = 31.33

c0 = Call premium received = 1.55

2. What is the breakeven stock price from writing a covered call?

3. What is the maximum loss from writing a covered call?

Solution to 1:

The covered call writer participates in gains up to the exercise price, after which further

appreciation is lost to the call buyer. That is, X S0 = 30.00 25.00 = 5.00. The call writer also

keeps c0, the option premium, which is 1.55. So, total maximum profit is 5.00 + 1.55 = 6.55.

Solution to 2:

The call premium of 1.55 offsets a decline in the stock price by the amount of the premium

received: 25.00 1.55 = 23.45.

Solution to 3:

The stock price can fall to zero, causing a loss of the entire investment, but the option writer still

gets to keep the option premium received: 25.00 1.55 = 23.45

As indicated earlier, a protective put position consists of a stock and a put option on that stock.

R42 Derivatives Strategies IFT Notes

The objective of a protective put is to protect against loss when the asset declines in value.

Buying a put option is like buying insurance. The analogy is outlined in the table below.

Premium Time Value

Value of asset Price of stock

Face value Exercise Price

Term of policy Time until option expiration

Likelihood of loss Volatility of stock

Example: An investor owns an IFT stock trading at $16.00 and buys one-month OCT 15 put for

1.00. In this case the put option is out-of-money. The exercise value = 0, and time value = 1.00.

Comparing the put option with insurance we can say that:

Insurance premium = time value = 1.00.

The value of asset = price of stock = 16.00.

Face value = exercise price = 15.00

Term of policy = Time until option expiration = one-month

Like insurance policies, a put implies a deductible which is equal to the stock price minus the

exercise price. This is the amount of loss the insured is willing to take. In the above example, the

deductible is 16.00 15.00 = 1.00.

0 15 17 B.E. Price ST

-2 Max Loss

The profit and loss relationships of the protective put are given below:

Maximum profit = ST S0 p0 = Unlimited

Maximum loss = S0 X + p0

Breakeven point = S0 + p0

Expiration value = Max(ST,X)

Profit at expiration = Max(ST,X) S0 p0

R42 Derivatives Strategies IFT Notes

S0 = Stock price when option position opened = 25.00

X = Option exercise price = 20.00

ST = Stock price at option expiration = 31.33

p0 = Put premium paid = 1.15

At Time 0 an investor creates a protective put position.

What is the profit at expiration?

What is the breakeven stock price?

What is the maximum possible loss?

Solution to 1:

Profit at expiration = ST S0 p0 = 31.33 25.00 1.15 = 5.18. If the stock price is above the

put exercise price at expiration, the put will expire worthless. The profit is the gain on the stock

(ST S0) minus the cost of the put. Note that the maximum profit with a protective put is

theoretically unlimited because the stock can rise to any level, and the entire profit is earned by

the stockholder.

Solution to 2:

Breakeven stock price = S0 + p0 = 25.00 + 1.15 = 26.15. Because the option buyer pays the put

premium, he does not begin to make money until the stock rises by enough to recover the

premium paid.

Solution to 3:

Maximum possible loss = S0 X + p0 = 25.00 20.00 + 1.15 = 6.15. Once the stock falls to the

put exercise price, further losses are eliminated. The investor paid the option premium, so the

total loss is the deductible plus the cost of the insurance.

A covered call potion where we are long N shares and short N at-the money call options is

equivalent to being long N shares and having a short forward positon of N/2 shares.

Portfolio 1: 100 shares of IFT + short 100 at-the-money call options

Portfolio 2: 100 shares of IFT + short forward potion on 50 IFT shares

This relationship stems from the fact that the delta of at-the-money call options is approximately

0.5. Hence the delta of Portfolio 1 is 100 0.5*100 = 50. The delta of Portfolio 2 is 100 50 =

50.

A cash-secured put is where an investor sells a put option and deposits an amount of money

equal to the exercise price into a designated account. This strategy is appropriate when an

investor has a bullish view on a stock or wants to acquire shares at a particular price.

Scenario: IFT stock is currently at 16.00. An investor wants to purchase the stock for 15.00. To

do so, the investor writes the SEP 15 put for 0.65 (Exhibit A). If the stock is above 15 at

R42 Derivatives Strategies IFT Notes

expiration the put option will expire worthless and the investor pockets the put premium. If the

stock is below 15 at expiration, the put would be exercised and the option writer purchases

shares at the exercise price of 15. The effective purchase price = exercise price put premium =

15 0.65 = 14.35.

The risk in writing covered call is the opportunity cost. The call writer sells the potential for

big gains. Example: Consider a covered call on the IFT stock selling at 16.00. The call

exercise price = 18.00 and call option premium = 1.00. If the stock rises to 25.00, the option will

be exercised by the holder. The covered call writer will not benefit from the increase in stock

price from 18 to 25.

With a protective put, the put option provides downside protection. But this protection is at a cost

because the put buyer must pay the option premium. Say an investor owns the IFT stock

currently at 16.00, and buys at-the-money put options for 1.14. If the put expires worthless,

continually buying puts in anticipation of a stock price decline this might wipe-out long-term

gains on the stock.

4.6. Collars

A collar consists of long shares of stock, a long put with an exercise price below the current

stock price and short call with an exercise price above the current stock price. Collars:

provide downside protection through a put

reduce the cash outlay by writing a call

Scenario: An investor owns a stock of XYZ company currently at $50. He buys the NOV 45 put

and simultaneously writes the NOV 55 call. Assume that the put premium is fully paid by the

call premium received. The profit and loss diagram for this collar is show below:

0 ST

45 50 55

-5

At or below the put exercise price of 45, the collar locks in a loss of 5.00. At or above the call

exercise price of 55, the profit is constant at 5.00.

An option spread is when an investor buys a call and writes another or buys a put and writes

R42 Derivatives Strategies IFT Notes

Bull and bear spreads represent cost-effective bets on the direction of the underlying. A bull

spread increases in value when the underlying rises. A bear spread increases in value when the

underlying falls.

Bull Spread

A bull spread can be created by combining two call options with different exercise prices or two

put options with different exercise prices. In this reading we will focus on creating bull spreads

using call options.

Scenario: Say the IFT stock is trading at $16 in August. If an investor believed that the stock

would not rise above $18 in two-months, he could use an OCT 16/18 bull call spread strategy. It

would be logical to sell off part of the return above $18 based on his outlook on the stock.

Consider the following:

buy the OCT 16 call option for 2.00

sell the OCT 18 call option for 1.00

the net cost is 2.00 1.00 = 1.00

The breakeven stock price and the maximum profit for bull spread are given by:

Breakeven price for a call bull spread = XL + (cL cH)

Maximum profit = XH XL (cL cH)

where,

XL = the lower exercise price, XH = the higher exercise price

cL = the lower-strike call, cH = for the higher-strike call

Maximum profit = 18 16 2 + 1 = 1.

Profit/Loss $

ST

16 17 18

-1

The maximum profit occurs at or above the exercise price of 18.

Notice that with this bull spread the investor benefits when the stock price increases. This

benefit arises because the investor bought the OCT 18 call option. The bull spread is considered

a cost-effective strategy because the cost of the OCT 18 is partially offset by selling the OCT 16

option.

R42 Derivatives Strategies IFT Notes

Bear Spread

With a bear spread the investor benefits when the underlying falls. A bear spread can be created

by combining two put options with different exercise prices.

Scenario: Say the IFT stock is at $16 in August. If an investor believes that the IFT stock will

decline to 14 by October, he can benefit by establishing an OCT 14/16 bear spread. To do this,

he should:

buy the IFT OCT 16 put for 2.00

sell the IFT OCT 14 put for 1.00

net cost of the spread = 2.00 - 1.00 = 1.00

The breakeven stock price and the maximum profit for bear spread are given by:

Breakeven price for a put bear spread = XH - (pH pL)

Maximum profit = XH XL (pH pL)

where,

XL = the lower exercise price, XH = the higher exercise price

pL = the lower-strike put, pH = the higher-strike put

Maximum profit = 16 14 (2 1) = 1.

Profit/ Loss $

1.00

0 14 15 16 ST

-1.00

Notice that with this bear spread the investor benefits when the stock price declines. This benefit

arises because the investor bought the OCT 16 put option. The bear spread is considered a cost-

effective strategy because the cost of the OCT 16 is partially offset by selling the OCT 14 put

option.

S0 = 44.50

OCT 45 call = 2.55 OCT 45 put = 2.92

OCT 50 call = 1.45 OCT 50 put = 6.80

1. What is the maximum gain with an OCT 45/50 bull call spread?

R42 Derivatives Strategies IFT Notes

2. What is the maximum loss with an OCT 45/50 bear put spread?

3. What is the breakeven point with an OCT 45/50 bull call spread?

Solution to 1:

With a bull spread, the maximum gain occurs at the high exercise price. At an underlying price

of 50 or higher, the spread is worth the difference in the strikes, or 50 45 = 5. The cost of

establishing the spread is the price of the lower-strike option minus the price of the higher-strike

option: 2.55 1.45 = 1.10. The maximum gain is 5.00 1.10 = 3.90.

Solution to 2:

With a bear spread, you buy the higher exercise price and write the lower exercise price. When

this strategy is done with puts, the higher exercise price option costs more than the lower

exercise price option. Thus, you have a debit spread with an initial cash outlay, which is the most

you can lose. The initial cash outlay is the cost of the OCT 50 put minus the premium received

from writing the OCT 45 put: 6.80 2.92 = 3.88.

Solution to 3:

You buy the OCT 45 call for 2.55 and sell the OCT 50 call for 1.45, for a net cost of 1.10. You

breakeven when the position is worth the price you paid. The long call is worth 1.10 at a stock

price of 46.10, and the OCT 50 call would expire out of the money and thus be worthless. The

breakeven point is the lower exercise price of 45 plus the 1.10 cost of the spread, or 46.10.

A calendar spread can be established by selling a near-dated call and buying a longer-dated one

on the same underlying asset and with the same strike. There are two types of calendar spreads:

Long calendar spread: sell near-dated call, buy long-dated call.

Short calendar spread: sell a longer-dated call, buy a near-term option.

Scenario: Suppose XYZ stock is trading at 45 in August. A trader believes that the stock will be

stable at current level for the year but will rise by early next year. He has access to options

shown below (taken from the curriculum):

Exercise Price SEP OCT JAN

40 5.15 5.47 6.63

45 1.55 2.19 3.81

50 0.22 0.62 1.99

Based on his outlook on the stock, the trader executes a calendar spread strategy. He buys XYZ

JAN 45 call for 3.81 and sells XYZ SEP 45 call for 1.55. The net cost is 3.81 1.55 = 2.26.

Assume that when the SEP 45 option expires, XYZ stock is at 45 and when the OCT 45 option

expires the stock is at 50. In this case the SEP 45 call is worthless but the JAN 45 option is in the

money.

In this example, the long calendar spread trader takes advantage of time decay. Time decay is

more pronounced for a short-term option than for a long time one. The long calendar spread

R42 Derivatives Strategies IFT Notes

trader exploits this by purchasing a longer-term option and writing a shorter-term option.

5.3. Straddle

A long straddle is created by buying a call and buying a put. The call and put should be on the

same underlying asset. The exercise price of the call and put should be the same. The party that

writes (sells) the call and put options takes a short straddle position.

A straddle is a directional play on the volatility of the underlying. A long straddle has a positive

payoff if the actual volatility of the underlying is higher than the expected volatility. A short

straddle has a positive payoff if the actual volatility of the underlying is less than the expected

volatility.

Assume a stock sells for 50, and the straddle buyer, invests in 30-day options with an exercise

price of 50. The call price is 2.29 and the put is 2.28, for a total cost of 4.57. For the trader to

make a profit, the stock must increase above 54.57 or decline below 45.43.

Notice that long straddle strategy has two breakeven points. The points are:

1. Exercise price + cost of buying the call and put options

2. Exercise price - cost of buying the call and put options

The risk of a long straddle is limited to the amount paid for the two option positions. The

movement in stock price therefore needs to be higher than the combined cost of the two options

for the position to make a profit. If the investor believes the movement in stock price would be

lesser than the combined option premiums, he or she should write the options instead i.e. take a

short straddle position.

R42 Derivatives Strategies IFT Notes

Risk of derivatives depends on how they are used in a strategy. Derivatives should be viewed as

neutral products that can create a preferred riskreturn trade-off when combined with other

assets to benefit the investor.

The appropriate option strategy depends on the volatility of the underlying and market

conditions. Exhibit 23 of the curriculum outlines the appropriate strategy under different market

conditions.

Exhibit 23. Direction and Volatility with Options Direction

Bearish Neutral/No Bias Bullish

High Buy puts Buy straddle Buy calls

Average Write calls Spreads Buy calls

Volatility

and buy puts and write puts

Low Write calls Write straddle Write puts

extremely bearish

extremely bullish

in between and to adjust along this continuum as required

Example: Say you own one million shares of HSBC Holdings. Can you temporarily reduce this

exposure by 10%, and convert to cash?

1. sell 100,000 shares, which is 10% of the holding.

2. sell a futures/forward contract of 100,000 shares.

3. write call contracts sufficient to generate minus 100,000 delta points.

4. buy put contracts sufficient to generate minus 100,000 delta points.

Option 1 (selling shares) will reduce the exposure to 10% but may cause a tax problem or

put downward pressure on the stock price.

Forward contracts involve counterparty risk and are difficult to unwind.

Writing calls brings in a cash premium, but subject to exercise risk.

Buying puts requires a cash investment but one can control exercise risk.

Key points from this section are summarized below:

Profit and loss diagram for option strategies are helpful in giving a range of possible

outcomes.

Option pricing theory helps in understanding breakeven prices but is based on an

assumption of future volatility.

R42 Derivatives Strategies IFT Notes

The current option price takes into account the volatility of the underlying asset.

Volatility is the standard deviation of the percentage changes in the spot price of the

underlying asset.

The volatility which gives the current option price in an option pricing model is called the

implied volatility. Option prices are often quoted as implied annualized volatilities;

Options can be compare by their implied volatilities. When expected volatility is higher

than the implied volatility, the option is underpriced.

Volatility indicates by how much a stocks price can be expected to move during a

particular time period. It therefore provides an estimate of the likelihood of reaching

breakeven points and hence the target price of the underlying.

Several factors determine option value: The underlying market price, the option exercise price,

the expiration time, the current risk-free rate, and dividends (if any) paid before expiration.

All these factors are observable or assessable. But if the expected volatility of the underlying

stock is higher, option premium will be higher. Implied volatility is the standard deviation

that causes an option pricing model to give the current option price.

Let us understand how annual volatility of a stock can be used to get information on the

likelihood of reaching the breakeven points prior to the trade. Consider a straddle where the call

option costs 2.29 and the put options costs 2.28, for a total cost of 4.57. The underlying stock is

trading at 50 and has an annual volatility of 30%.

For breakeven, the stock should be = (cost of both put and call) units from the

current price of 50, hence of stock movement required. Expiration is in 30

calendar days which corresponds to 21 trading days. The 9.14% number can be converted to an

annualized return and an annualized volatility. In the calculations below we assume a 252 day

year.

The annualized standard deviation is calculated by multiplying 9.14% by the square root of

252/21.

annual= = 31.66% 32%.

The required annual volatility for reaching the breakeven point exceeds the historical level

marginally, therefore establishing the straddle seems favourable. If, instead, the same straddle

costs 7.00 to establish, then a 7/50 = 14% move is required to reach a breakeven point.

As the required volatility for such a move is much higher than the historical volatility of 30%,

the move is unlikely to occur and therefore the straddle does not seem feasible over a 30-day

period.

R42 Derivatives Strategies IFT Notes

XYZ stock = 100.00

100-strike call = 8.00

100-strike put = 7.50

Options are three months until expiration.

A. high volatility market.

B. low volatility market.

C. average volatility market.

A. 92.50 and 108.50.

B. 92.00 and 108.00.

C. 84.50 and 115.50.

A. 16%.

B. 31%.

C. 62%.

Solution to 1:

A is correct. A straddle is directionally neutral; it is neither bullish nor bearish. The straddle

buyer wants volatility and wants it quickly, but does not care in which direction. The worst

outcome is for the underlying asset to remain stable.

Solution to 2:

C is correct. To break even, the stock price must move enough to recover the cost of both the put

and the call. These premiums total $15.50, so the stock must move up to $115.50 or down to

$84.50.

Solution to 3:

C is correct. The price change to a breakeven point is 15.50 points, or 15.5% on a 100 stock.

15.5% over three months is roughly equivalent to an annualized rate of 62% because 15.5%

12/3 = 62%. In this question, we were asked to calculate the annualized return and hence we

multiplied by 12/4. If we were asked to calculate the annualized standard deviation, we would

have to multiply 15.5% by the square root of 12/4 which would have given an answer of 31%.

6.4. Applications

This section includes mini cases that discuss different investors and their use of derivatives to

solve a particular client situation.

R42 Derivatives Strategies IFT Notes

Client situation: Carlos Riveras client needs to raise $30,000 relatively quickly for wedding

expenses of her daughter. The clients portfolio is 100% invested in equities and, by policy, is

aggressive. Client is asset rich and cash poor. Revised investment policy statement permits all

option activity except the writing of naked calls. Portfolio account has 5,000 shares of Apple

stock.

4.90 97 2.14

3.25 100 3.45

2.02 103 5.23

Market outlook: Next six months, a flat to slightly bearish market outlook.

Solution: The clients account allows writing of covered calls and also writing puts. The options

trade on the exchange with a standard contract size of 100 options. With 5,000 shares of the

stock, the client can write a maximum of 5000/100 = 50 call option contracts. Even though the

100 and 103 calls are more likely to expire out of money, they are cheaper and the client does not

have sufficient shares in the portfolio to write enough calls to meet the cash requirement. Given

the market outlook and Apples stock price, Rivera could recommend writing covered call on

Apple shares - 50 contracts of the MAY 97 calls which would generate 50 x 100 x 4.90 =

$24,500 and to meet the income shortfall. The still needs $5,500. This can be raised by selling

5,500 / (100 x 2.14) 26 put option contracts.

Client Situation: The account holds 100,000 shares of Salar Limited, currently trading at

HK$42.00. Salar has an upcoming earnings announcement. The one month options on the stock

are as follows:

3.05 40.0 1.04

1.69 42.5 2.19

0.84 45.0 3.83

Market Outlook: Despite an expected earnings increase, the company might narrowly miss the

consensus earnings estimate. Consequently, the position might decline.

Solution: Skaves considers writing covered calls to protect the clients position in the stock until

the report is released. The advantage of this strategy is that some income is generated. The

disadvantages are:

The protection is limited.

R42 Derivatives Strategies IFT Notes

If the underlying stock rises above the exercise price, there is an opportunity cost. In this

example, if the companys earnings are above the market expectations, then the stock

might rise and Skaves will have to forego any gains above the option exercise price.

An alternative is a protective put, maybe with an exercise price below the current stock price

such as the $40 put, and selling it shortly after the earnings announcement if the stock price rises.

The put will protect against the decline in the price if earnings are lower than expectations. If the

earnings are higher than expectations, the put can be sold near purchase price immediately after

the announcement.

Client Situation: Salars earnings beat the consensus estimate and shortly after the

announcement the stock rose 10% to HK$46.20.

Market Outlook: This increase in stock price is not justified by the new earnings level, hence

the stock may give up about half of this gain in the coming weeks. The new options prices show

an increase due to anticipated volatility in the stock. The options are now valued as:

7.03 40.0 0.83

5.24 42.5 1.54

3.76 45.0 2.56

2.61 47.5 3.90

Solution: Given the short-term view about Salar stock, he might also consider writing a call with

an exercise price of either 45.00 or 47.50, especially because of increased volatility. When

options are expensive, writing them can result in higher income, but there is always the risk that

the stock does not fall and the call will be exercised.

Client Situation: A 100,000 share holding in Targa, currently selling for 14. The client has a

tax basis that is low. Steinbacher wants to protect the value of the position and an outright sale

will not be feasible because of tax consequences.

Solution 1: He might enter a collar strategy: buy a put and then write a call to offset the put

premium. The put provides downside protection below the put exercise price, and the

call premium offsets the cost of the put. This strategy sacrifices large gains in the stocks value

for protection against large losses and offsets the upfront protection cost.

Solution 2: An alternative would be to enter into an equity swap: trading the Targa return for

Libor. Steinbacher can agree to exchange the total return on the shares for the Libor return with a

swap tenor of six months. If the Targa return is higher than Libor, Steinbacher would pay the

difference. If the Targa stock return is less than the Libor return, Steinbacher would receive

difference between the LIBOR return and Targa return.

R42 Derivatives Strategies IFT Notes

Client Situation: Quintera wants to buy 500,000 shares of a company at a price of $87.50 or

less. The shares are currently trading at $89.00.

Solution: Quintera can write in-the-money puts which provide put premium. For instance, he

writes $95 puts for the stock which sell for $7.85. At expiration, if the stock price is below the

exercise price, the puts will be exercised and Quintera would have to buy the stock at $95. After

adjusting for the put premium of 7.85, the net cost would be $87.15. If the stock is above the

exercise price at expiration, the option will not be exercised and there will be an opportunity cost

of not purchasing at the current stock price.

Client Situation: Katrina has been following McMillan Holdings for one year. The company is

involved in a costly lawsuit, and she is considering a volatility play with a straddle strategy. She

intends to buy at the money calls and puts in anticipation that the volatility will increase as the

verdict is read and options prices will increase.

Market Outlook: Stock is selling for $75.00. At-the-money calls and puts selling for

2.58 and 2.57, respectively. A jury verdict on McMillan is expected the next day and a stock

movement of anticipated. The following day option prices are higher at 6.00 for the call

and 5.99 for the put, although stock still trading at $75.

Solution: When the call and put prices were initially at 2.58 and 2.57, the total option cost would

have been 2.58 + 2.57 = 5.15. As Katrina was expecting a 10% stock price movement i.e. $7.5,

the move would have covered the option cost. However, once option prices rose, the total option

increased to 6.00 + 5.99 = 11.99. A 10% stock price move would not be enough to cover this

cost and hence the straddle is less likely to be profitable.

Client Situation: Akota anticipates a spike in price of a certain stock over a short period of time

and wants to benefit from this.

Market Outlook: The stock is expected to increase from 60 to 65 in the next 30 days. The

market is bullish and volatile. The 30-day call options with an exercise price of 60 are selling at

4.00 and Akota believes they are overpriced. The 30-day call options with an exercise price of 65

are at 1.50.

Solution: Since 60 call is overpriced at 4.00, and the market is bullish, a call bull spread is the

appropriate strategy. Akota can buy the 60 call at 4.00 and sell the 65 call at 1.50, for a net cost

of 4.00 - 1.50= 2.50. As the price of the stock is expected to increase to 65.00, the short call

will expire at the money. Akotas profit would be on the initial

investment of 2.50.

R42 Derivatives Strategies IFT Notes

Client Situation: The client wants a long exposure in the stock but does not want to pay the

premium on a short-term call.

Market Outlook: Stock selling for SEK 30, and expected to stay within a narrow range for the

next month until a new product is announced and is then expected to increase. 15-day, 30-strike

calls are priced at SEK 1. 45-day, 30-strike calls are priced at SEK 1.50.

Solution: The appropriate strategy is a calendar spread. By selling a 15-day, at-the-money call

with a strike of 30 for 1, and buying a 45-day, 30-strike call for 1.50, she is lowering the net

premium she pays. She is essentially selling the time value of the shorter term option. Her net

cost = 1.50 1.00 = 0.50. If the stock increases after the short call expires, she takes full benefit

of the price increase. If the stock does not rise, her maximum loss is SEK0.50.

Client Situation: A Mexican firm expects a receipt in three months of $4 million and wants to

minimize foreign exchange risk.

Solution: The firm can enter into a three-month forward contract to sell $4 million in exchange

for pesos. By doing so the Mexican firm locks in the rate at which it can convert the dollars into

pesos.

Client Situation: Bonshaw Bank issued C$400 million worth of long-term, fixed-rate mortgage

loans. The bank wants to reduce its interest rate risk exposure.

Solution: The bank has issued fixed rate mortgage loans which means that it receives fixed

interest payments. The bank can hedge its interest rate risk by entering into a swap where it pays

the fixed rate and receives a floating rate.

- CFA Level I- Financial Reporting and Analysis- SMG.pdfЗагружено:FinTree Education Pvt Ltd
- R41_Valuation_of_Contingent_Claims_IFT_Notes.pdfЗагружено:Zidane Khan
- R40_Pricing_and_Valuation_of_Forward_Commitments_IFT_Notes.pdfЗагружено:Zidane Khan
- Financial Analyst CFA Study Notes: Quantitative Methods Level 1Загружено:Andy Solnik
- CFA Level 1 Ethical Standards NotesЗагружено:Andy Solnik
- Instrumentos Financieros Para Cobertura Del Riesgo- Parte IЗагружено:RZabal
- R42_Derivative_Strategies_Q_Bank.pdfЗагружено:Zidane Khan
- PS 2 SolutionЗагружено:wasp1028
- CFA Level 1 Corporate Finance E book - Part 1.pdfЗагружено:Zacharia Vincent
- R28-Financial-Analysis-Techniques-IFT-Notes.pdfЗагружено:Noor Salman
- R37_Valuation_and_Analysis_Q_Bank.pdfЗагружено:Zidane Khan
- ICAEW Financial ManagementЗагружено:cima2k15
- Fixed Income > YCM 2001 - Interest Rate DerivativesЗагружено:api-27174321
- David Bukey - The S&P Witch ProjectЗагружено:Jack Jensen
- i Cici Trading ConditionsЗагружено:morpheus
- 2012-06_CFA_L2_100_forecastЗагружено:Afaque Mehmood Memon
- Simple Options TradingЗагружено:finnthecelt
- Intro to Options Webinar NotesЗагружено:Mallikarjun Reddy Chagamreddy
- R44_Publicly_Traded_Real_Estate_Securities_Q_Bank.pdfЗагружено:Zidane Khan
- R47_The_Porfolio_Management_Process_and_the_IPS_Q_Bank.pdfЗагружено:Zidane Khan
- R48_Introduction_to_Multifactor_Models_Q_bank.pdfЗагружено:Zidane Khan
- R50_Economics_and_Investment_Markets_Q_Bank.pdfЗагружено:Zidane Khan
- R46_Commodities_and_Commodity_Derivatives__Q_Bank.pdfЗагружено:Zidane Khan
- R52_Algorithmic_Trading_and_High-Frequency_Trading_Q_Bank.pdfЗагружено:Zidane Khan
- (Handbook of Agricultural Economics 1, Part B) Bruce L. Gardner and Gordon C. Rausser (Eds.)-Marketing, Distribution and Consumers-North Holland (2001)Загружено:Kevin Devalentino
- Abstract (1)Загружено:Vikram Waraich Insan
- Level I Volume 1 2018 IFT Notes.pdfЗагружено:Bindesh Agarwalla
- SIP quantum.pdfЗагружено:Faheem Qazi
- Caso Harvard - PixonixЗагружено:Marco Antonio Orellana Bonilla
- Beginners Guide Trading Gold Silver OptionsЗагружено:mohan

- R45_Private_Equity_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R47_The_Porfolio_Management_Process_and_the_IPS_Q_Bank.pdfЗагружено:Zidane Khan
- R46_Commodities_and_Commodity_Derivatives__Q_Bank.pdfЗагружено:Zidane Khan
- R48_Introduction_to_Multifactor_Models_Q_bank.pdfЗагружено:Zidane Khan
- R50_Economics_and_Investment_Markets_Q_Bank.pdfЗагружено:Zidane Khan
- R52_Algorithmic_Trading_and_High-Frequency_Trading_Q_Bank.pdfЗагружено:Zidane Khan
- R36_The_Arbitrage-Free_Valuation_Framework_Q_Bank.pdfЗагружено:Zidane Khan
- R41_Valuation_of_Contingent_Claims_Q_Bank.pdfЗагружено:Zidane Khan
- R39_Credit_Default_Swaps_Q_Bank.pdfЗагружено:Zidane Khan
- R43_Private_Real_Estate_Investments_Q_Bank.pdfЗагружено:Zidane Khan
- R44_Publicly_Traded_Real_Estate_Securities_Q_Bank.pdfЗагружено:Zidane Khan
- R37_Valuation_and_Analysis_Q_Bank.pdfЗагружено:Zidane Khan
- R42_Derivative_Strategies_Q_Bank.pdfЗагружено:Zidane Khan
- R38_Credit_Analysis_Models_Q_Bank.pdfЗагружено:Zidane Khan
- R40_Pricing_and_Valuation_of_Forward_Commitments_Q_Bank.pdfЗагружено:Zidane Khan
- R34_Private_Company_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R30_Discounted_Dividend_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R23_Dividends_and_Share_Repurchases_Q_Bank.pdfЗагружено:Zidane Khan
- R26_Mergers___Acquisitions_Q_Bank.pdfЗагружено:Zidane Khan
- R28_Return_Concepts_Q_Bank.pdfЗагружено:Zidane Khan
- R29_Industry_and_Company_Analysis_Q_Bank.pdfЗагружено:Zidane Khan
- R33_Residual_Income_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R27_Equity_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R25_Corporate_Governance_Q_Bank.pdfЗагружено:Zidane Khan
- R35_The_Term_Structure_and_Interest_Rate_Dyamics_Q_Bank.pdfЗагружено:Zidane Khan
- R32_Market-Based_Valuation_Q_Bank.pdfЗагружено:Zidane Khan
- R31_Free_Cash_Flow_Valuation_Q_Bank.pdfЗагружено:Zidane Khan

- Sales Digests VЗагружено:VanillaSkyIII
- HedgeЗагружено:api-3748231
- Security Analysis Syllabus IBSЗагружено:nitin2kh
- Doing Business in Brazil 2011Загружено:johanmateo
- Weekly Commodity Review- 7 - 11 May 2012Загружено:gordju
- MCX Annual Report FY2015Загружено:Da Baul
- BfdЗагружено:Ramzan Ali
- Raj Option (1)Загружено:Pearlboy Muthuselvan N
- CIMA P3 Management Accounting Risk and Control Strategy Solved Past PapersЗагружено:Shahid Imtiaz
- FINC3012 - Interest Rate Futures and OptionsЗагружено:Lucas Ting
- POF_Week_9_SB (2)Загружено:partyycrasher
- Asx 24 Interest Rate Price and Valuation GuideЗагружено:Kai Chen
- ABC Pattern and Trade Wave cЗагружено:ANIL1964
- Basmati Rice ReportЗагружено:Merlyn Correa
- Audit Treasury Bank of IndiaЗагружено:Abdul Basit AB
- 082112 the New Derivatives Definitions What Fund Managers Need to KnowЗагружено:DougBlue_2012
- Hirozuko Miyazaki. the Temporalities of the MarketЗагружено:Vanessa Ogino
- Mccp Commodity Programme Dlp EnglishЗагружено:anubhavg82
- 324_Foreign Exchange Market-ForEXЗагружено:Tamuna Bibiluri
- Profiting With Futures and OptionsЗагружено:johnsm2010
- MBA 401Загружено:Neelanjan Hazra
- Blades Inc. CaseЗагружено:planet_sami
- Module1Загружено:api-3773732
- 10.1016 J.jempFIN.2015.07.001 Market Sentiment in Commodity Futures ReturnsЗагружено:saman
- 50 Golden Rules for TradersЗагружено:Navneet Maurya
- Sheldon Natenberg-Option Volatility and Pricing_ Advanced Trading Strategies and Techniques-McGraw-Hill Education (2014)Загружено:rejaulmeister
- Issue 64Загружено:Alex
- Project Report on Commodity Trading at IIFlЗагружено:Narayan Sharma Pdl
- MRPL_LDCHЗагружено:Niveditha Gadamchetty
- Brock Wang Jiahui 2015Загружено:Alexandra-Nicoleta Mateescu

## Гораздо больше, чем просто документы.

Откройте для себя все, что может предложить Scribd, включая книги и аудиокниги от крупных издательств.

Отменить можно в любой момент.