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Basic Option Strategies

FX Derivatives Seminar
27th November 2004
Raphael Drescher
Commonly Used Strategies

♦ Risk Reversal
♦ Bull-/ Bearspread
♦ Seagull
♦ Straddle/ Strangle

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Risk Reversal

♦ Go long via RR as alternative to forward

♦ Example (spot 1.3000):
— Buy 2m 1.3500 EUR Call/ USD Put
— Sell 2m 1.2500 EUR Put/ USD Call
— Zero premium
0.1500

0.1000 RR Payout

P&L at expiry 0.0500

0.0000

-0.0500

-0.1000

-0.1500
1.15 1.25 1.35 1.45
EURUSD Spot at Expiry

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Bull-/ Bearspread (Call-/ Put- Spread)

♦ Go long via Bull (or Call) Spread as alternative to forward or plain

vanilla option

♦ Example (spot 1.3000):

— Buy 2m 1.3000 EUR Call/ USD Put
— Sell 2m 1.3500 EUR Call/ USD Put
— Premium: 0.0145 USD per EUR ( plain vanilla would cost 210 USD pips)

0 .05 00

0 .04 00

0 .03 00
P&L at expiry

0 .02 00

0 .01 00
S pread P ay out
0 .00 00

-0 .01 00

-0 .02 00

-0 .03 00
1.25 1 .30 1 .35 1.4 0
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Bull-/ Bear Seagull

♦ Go long via Seagull as alternative to forward or plain vanilla

option

♦ Example (spot 1.3000):

— Buy 2m 1.3200 EUR Call/ USD Put
— Sell 2m 1.3700 EUR Call/ USD Put
— Sell 2m 1.2700 EUR Put/ USD Call
— Zero premium
0.0600

0.0500

0.0400

0.0300
P&L at expiry

0.0200

0.0100
Bull Seagull Payout
0.0000

-0.0100

-0.0200

-0.0300
1.25 1.27 1.29 1.31 1.33 1.35 1.37 1.39

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Straddle

♦ Go long/ short via Straddle

♦ Example (spot 1.3000):
— Buy 2m 1.3000 EUR Call/ USD Put
— Buy 2m 1.3000 EUR Put/ USD Call
— Premium 0.0400 USD per EUR
— Break-Even 1.2600 and 1.3400

0.1500

0.1000
Straddle Payout
P&L at expiry

0.0500

0.0000

-0.0500
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EURUSD Spot a t Ex piry 5
Strangle

♦ Go long/ short via Strangle

♦ Example (spot 1.3000):
— Buy 2m 1.3200 EUR Call/ USD Put
— Buy 2m 1.2800 EUR Put/ USD Call
— Premium 0.0230 USD per EUR
— Break-Even 1.2570 and 1.3430

0.1000

Strangle Payout

0.0500
P&L at expiry

0.0000

-0.0500
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EURUSD Spot at Expiry 6
Standard Option Strategies

Long Call Long Put Bull Spread Long Strangle

+ A + A + A + A B
0 0 0 0
– – – B –
Structure: Long Call A. Structure: Long Put A. Structure: Long Call A and Short Call B. Structure: Long Put A and Long Call B.
Currency Currency Currency Currency
View: Bullish. Use when the value of the underlying View: Bearish. Use when the value of the underlying View: Bullish. Use when the value of the underlying View: Use when the value of the underlying asset is
asset is expected to increase. asset is expected to decrease. asset is expected to increase moderately. expected to increase or decrease.

Strike Strike Strike Strike

Selection: Any long call strike will represent a bullish view Selection: Any long put strike will represent a bearish Selection: The more bullish the view of the underlying Selection: A and B will be selected when the under-lying
of the underlying asset. For high leverage, buy view of the underlying asset. For high leverage, asset, the greater the distance between selected asset value is between A and B.
out-of-the money strikes. buy out-of-the money strikes. strikes.
Payoff: Profit unlimited as value of the underlying asset
Payoff: Profit unlimited as value of the underlying Payoff: Profit unlimited as value of the underlying Payoff: Profit limited. Loss limited. increases or decreases. Loss limited to premium
asset increases. Loss limited to premium asset decreases. Loss limited to premium paid. paid.
paid. Volatility
Volatility View: Bullish. Volatility
Volatility View: Bullish. View: Bullish. Use when the volatility of the underlying
View: Bullish. asset is expected to increase.

Short Call Short Put Bear Spread Short Strangle

+ + + B +
0 0 0 0
– A – A – A – A B

Structure: Short Call A. Structure: Short Put A. Structure: Short Put A and Long Put B. Structure: Short Put A and Short Call B.

Currency Currency Currency Currency

View: Bearish. Use when the value of the underlying View: Bullish. Use when the value of the underlying View: Bearish. Use when the value of the underlying View: Neutral. Use when the underlying asset value is
asset is expected to remain stable or decrease asset is expected to remain stable or increase asset is expected to decrease moderately. expected to stabilize within a range.
slightly. slightly.
Strike Strike
Strike Strike Selection: The more bearish the view of the underlying Selection: A and B will will be selected when the underlying
Selection: The more bearish the view of the underlying Selection: The more bullish the view of the underlying asset, the greater the distance between the asset value is between A and B.
asset, the more the selected strike should be in- asset, the more the selected strike should be in- selected strikes.
the-money. the-money. Payoff: Profit unlimited to premium paid. Loss unlimited
Payoff: Profit limited. Loss limited. as value of the underlying asset increases or
Payoff: Profit limited to premium received. Loss unlimited Payoff: Profit limited to premium received. Loss unlimited decreases.
as value of the underlying asset increases. as value of the underlying asset decreases. Volatility
View: Bullish. Volatility
Volatility Volatility View: Bearish. Use when the volatility of the underlying
View: Bearish. View: Bearish. asset is expected to decrease.

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Option Strategies (continued)
Long Straddle Call Ratio Spread Call Ratio Backspread Long Butterfly

+ A + A + B + A C
0 0 0 0
– – B – A – B

Structure: Long Call A and Long Put A. Structure: Long Call A and Short 2 Calls B. Structure: Short Call A and Long 2 Calls B. Structure: Long Call A, Short 2 Calls B, and Long Call C.
Currency Currency Currency Currency
View: Use when the value of the underlying asset is View: Mildly Bullish. Use when the value of the View: Bullish. Use when the value of the underlying View: Neutral. Use when the underlying asset value is
expected to increase or decrease. underlying asset is likely to increase slighty. asset is likely to increase. likely to remain near current levels.

Strike Strike Strike Strike

Selection: A will be selected when the value of the Selection: A and B will be selected when the underlying Selection: A and B will be selected when the underlying Selection: A, B,and C will be selected when the value
underlying asset is near A. asset value is near A. asset value is near B. underlying asset value is near B.

Payoff: Loss limited to premium paid. Maximum loss is Payoff: Profit limited and maximised at B. Loss unlimited Payoff: Profit unlimited as value of the underlying asset Payoff: Profit limited and maximised at B. Loss limited
at A. as value of the underlying asset increases. Loss increases. Profit limited as value of the to net premium paid.
limited as value of the underlying asset underlying asset decreases. Loss limited and
Volatility decreases. maximised at B. Volatility
View: Bullish. Use when the volatility of the underlying View: Bearish. Use when the volatility of the underlying
asset is expected to increase Volatility Volatility value asset is expected to decrease.
View: Bearish. Use when the volatility of the underlying View: Bullish. Use when the volatility of the underlying
asset is expected to decrease asset is expected to increase

Short Straddle Put Ratio Spread Put Ratio Backspread Short Butterfly

+ + B + A + B
0 0 0 0
– A – A – B – A C

Structure: Short Call A and Short Put A. Structure: Short 2 Puts A and Long Put B. Structure: Long 2 Puts A and Short Put B. Structure: Short Call A, Long 2 Calls B, and Short Call C.

Currency Currency Currency Currency

View: Neutral. Use when the underlying asset value is View: Mildy bearish. Use when the value of the View: Bearish. Use when the value of the underlying View: Use when the value of the underlying asset is
expected to remain stable. underlying asset is likely to decrease slightly. asset is likely to decrease. likely to increase or decrease.

Strike Strike Strike Strike

Selection: A will be selected when the value of the Selection: A and B will be selected when the underlying Selection: A and B will be selected when the underlying Selection: A, B, and C will be selected when the underlying
underlying asset is near A. asset value is near A. asset value is near A. asset value is near B.
Payoff: Profit limited to premium received. Loss unlimited Payoff: Profit limited and maximised at A. Loss limited as Payoff: Profit unlimited as value of the underlying asset Payoff: Profit limited and maximised below A and above
as value of the underlying asset increases or value of the underlying asset increases. Loss decreases. Profit limited as value of the C. Loss limited and maximised at B.
decreases. unlimited as value of the underlying asset underlying asset increases. Loss limited and
decreases. maximised at A. Volatility
Volatility View: Bullish. Use when the volatility of the underlying
View: Bearish. Use when volatility of the underlying Volatility Volatility asset is expected to increase, but not beyond a
asset value is expected to decrease. View: Bearish. Use when the volatility of the underlying View: Bullish. Use when the volatility of the underlying certain range.
asset is expected to decrease. asset is expected to increase.

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