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Step 3: The net cost out of these trading is Rs 42.00 (Rs 44.00-Rs
2.00). The options will not be exercised when the market price at
expiry date is greater than Rs 660. In that situation the net loss
for the investor is the loss of entering into the option contracts
i.e., Rs 42.
A butterfly spread takes three call prices all having the same expiry
date into consideration. A butterfly call spread is created by buying a
call option with a low strike price, another call option with a high
strike price, and selling two call options with a strike price in between
the high and low strike prices.
When the share price in the market moves between the low and high
prices, the investor makes a profit from the butterfly spread position.
When the share price moves nearer to the low and high prices and
goes beyond these points the investor incurs a loss, ie, cost of entering
into the butterfly strategy. The following example uses a butterfly
spread.
55 6.70 28/11/2002
60 3.85 28/11/2002
65 1.95 28/11/2002
The investor buys one call option with a strike price of Rs 55 and Rs 65
and pays a premium of Rs 8.65 (Rs 6.70 + Rs 1.95). The investor also
sells two call options at the strike price ofRs 60, receiving Rs 7.70 (Rs
3.85 * 2). The net cost of the strategy is Rs 0.95 (Rs 8.65-Rs 7.70).
4
Straddles
Combining a long call and a long put creates a long straddle. The
simultaneous purchase of a call and a put on the same security, with
the same exercise price, and for the same expiry month results in a
long straddle. A short straddle, on the other hand, is the simultaneous
sale of a call and put option with the same exercise price and with the
same expiry time.
The holder of the long straddle would make net profits if the share
price moved outside the range Rs 93-Rs 107 (break-even points). The
maximum loss would be Rs 7, the sum of the premiums paid. This loss
would be incurred if the share price moved to and stayed at Rs 100.
Strangles
Strangles are similar to straddles but they differ since the two options
will have different exercise prices, though the date of expiry is the
same.