Chapter 12

Trading Strategies I nvolving

Options
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014 1
Strategies to be Considered

Bond plus option to create principal
protected note
Stock plus option
Two or more options of the same type (a
spread)
Two or more options of different types (a
combination)
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
2
Principal Protected Note
Allows investor to take a risky position without
risking any principal
Example: $1000 instrument consisting of
3-year zero-coupon bond with principal of $1000
3-year at-the-money call option on a stock
portfolio currently worth $1000
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
3
Principal Protected Notes continued
Viability depends on
Level of dividends
Level of interest rates
Volatility of the portfolio
Variations on standard product
Out of the money strike price
Caps on investor return
Knock outs, averaging features, etc


Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
4
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Positions in an Option & the Underlying
(Figure 12.1, page 257)

Profit
S
T
K
Profit
S
T
K
Profit
S
T
K
Profit
S
T
K
(a)
(b)
(c) (d)
5
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Bull Spread Using Calls
(Figure 12.2, page 258)

K
1
K
2
Profit
S
T
6
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Bull Spread Using Puts
Figure 12.3, page 259
K
1
K
2
Profit
S
T
7
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Bear Spread Using Puts
Figure 12.4, page 260
K
1
K
2
Profit
S
T
8
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Bear Spread Using Calls
Figure 12.5, page 261
K
1
K
2
Profit
S
T
9
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Box Spread
A combination of a bull call spread and a bear
put spread
If all options are European a box spread is
worth the present value of the difference
between the strike prices
If they are American this is not necessarily so
(see Business Snapshot 11.1)

10
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Butterfly Spread Using Calls
Figure 12.6, page 262
K
1
K
3
Profit
S
T
K
2
11
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Butterfly Spread Using Puts
Figure 12.7, page 264
K
1
K
3
Profit
S
T
K
2
12
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Calendar Spread Using Calls
Figure 12.8, page 265
Profit
S
T
K
13
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Calendar Spread Using Puts
Figure 12.9, page 266
Profit
S
T
K
14
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
A Straddle Combination
Figure 12.10, page 267
Profit
S
T
K
15
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
Strip & Strap
Figure 12.11, page 268

Profit
K S
T
Profit
K S
T
Strip Strap
16
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
A Strangle Combination
Figure 12.12, page 269
K
1
K
2
Profit
S
T
17
Other Payoff Patterns
When the strike prices are close together a
butterfly spread provides a payoff consisting
of a small spike
If options with all strike prices were available
any payoff pattern could (at least
approximately) be created by combining the
spikes obtained from different butterfly
spreads
Options, Futures, and Other Derivatives, 9th Edition,
Copyright John C. Hull 2014
18