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Involving Options
05 Lecture
Dr. Guillermo Benavides
05 Lecture
Trading Strategy
A combinations strategy involves taking a
position in both calls and puts on the same
underlying asset. It is appropriate strategy
if the investors believes that the underlying
asset price will be very volatile.
05 Lecture
Spreads
A trading strategy that involves taking a
position in two or more options of the
same type (i.e. two or more calls or two or
more puts).
05 Lecture
Bull spread
It is created by buying a call option on a
stock with a certain strike price and selling
a call option on the same stock with a
higher strike price. Both options have the
same expiration date.
Investor hopes stock price will increase.
+ 1.00
+ 0.50
0
K1
Precio spot
(Pesos/USD)
K2
- 0.50
- 1.00
Loss
+ 1.00
+ 0.50
0
K1
Precio spot
(Pesos/USD)
K2
- 0.50
- 1.00
Loss
05 Lecture
Bear spread
Buying a call with one strike price and
selling a call with a lower strike price. Both
calls expire at the same date.
Investor hopes stock price will decrease.
+ 1.00
+ 0.50
0
K1
Precio spot
(Pesos/USD)
K2
- 0.50
- 1.00
Loss
+ 1.00
+ 0.50
0
K1
Precio spot
(Pesos/USD)
K2
- 0.50
- 1.00
Loss
05 Lecture
Butterfly spread
Involves taking positions in options with
three different strikes.
Buying a call option with a relatively low
strike price, buying a call option with a
relatively high strike price and selling two
calls with a strike price halfway between
the stike prices of the long positions.
10
05 Lecture
Stock
price
range
Payoff
Payoff
Payoffs
from 1st from 2nd short
long call long call calls
Total
payoffs
ST < K1
K1<ST<K2
ST - K1
ST - K1
K2<ST<K3
ST - K1
-2(ST-K2)
K3 - ST
ST > K3
ST - K1
ST K3
-2(ST-K2)
11
05 Lecture
For the previous Table, the payoffs are
calculated usig the relationship
K2 = 0.5(K1 + K3)
12
+ 1.00
+ 0.50
0
K1
K2
Precio spot
(Pesos/USD)
K3
- 0.50
- 1.00
Loss
13
05 Lecture
Straddle
Involves buying a call and put with the
same strike price and expiration date.
14
Straddle
Profit
(Pesos/USD)
+ 1.00
+ 0.50
0
Precio spot
(Pesos/USD)
- 0.50
- 1.00
Loss
15
05 Lecture
Strangle
Also called a bottom vertical combination
involves buying a call and a put with the
same expiration date but different exercise
prices.
16
Strangle
Profit
(Pesos/USD)
+ 1.00
+ 0.50
0
K1
Precio spot
(Pesos/USD)
K2
- 0.50
- 1.00
Loss
17
05 Lecture
Risk-reversal
Involves taking a long position on an outof-the-money call and short position in an
out-of-the-money put with the same time
to expiration.
18
Risk-Reversal
Profit
(Pesos/USD)
+ 1.00
+ 0.50
0
K1
K2
K3
Precio spot
(Pesos/USD)
- 0.50
- 1.00
Loss
19
05 Lecture
Barrier options
Options where the payoffs depends on whether
the underlying assets price reaches a certain
level during a certain period of time.
These type of options normally trade in the overthe-counter market.
They are attractive because are less expensive
than relevant regular options.
20
05 Lecture
Knock-out and knock-in options
A knock-out option ceases to exist when
the underlying asset price reaches a
certain barrier; a knock-in option comes
into existence only when the underlying
asset price reaches a barrier.
21
05 Lecture
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23
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24
Barrier Options
Knock-Out: Up & Out Call
H>K
Ceases to exists
(Pesos/USD)
14
13
12
11
10
Time
25
Barrier Options
Knock-In: Up & In Call
H<K
(Pesos/USD)
In the Money
14
K
13
12
Comes to existence
11
10
Time
26
Barrier Options
Knock-In: Up & In Call
H>K
(Pesos/USD)
Comes to existence
H
14
13
12
11
10
Time
27
Barrier Options
Knock-Out: Down & Out: Put (Sell Pesos)
H<K
(USD/Pesos)
0.10
0.09
0.08
Ceases to exists
0.07
0.05
H
Time
28
Barrier Options
0.10
0.09
Comes to existence
0.08
H
0.07
K
0.05
Time
29
Barrier Options
Knock-in: Down & In: Put
H<K
(USD/Pesos)
0.10
0.09
0.08
Comes to existence
0.07
0.05
H
Time
30