6 - Advanced Options Strategies and Valuation Flashcards
What is a straddle?
A straddle strategy involves creating a portfolio with a
Long position in both a Put and a Call at the same strike price.
With a straddle strategy what happens if the price St falls below K?
The Long Put is In-The-Money.
The Long Call is Out-of-the-Money
With a straddle strategy what happens if the price St rises above K1?
The Long Put is Out-of-the-Money.
However, the Long Call is In-the-Money.
When does a positive payoff occur?
Positive payoff only occurs if the Share Price moves beyond
the combined premium cost of the Options. So this is a portfolio
that is assumes a very high level of Volatility and if ST at
inception is equal to K1 is neutral on directional volatility
What is a strangle strategy?
A strangle strategy is a portfolio with a Long position in
both a Put and a Call Option. The strike price for the Call
option is set at a higher level than the strike price for the
Put option.
» The further apart the strike prices are, the larger the
price variation will have to be for the strategy to make
money. The main reason for using strangles rather than
straddles is cost – strike prices further from the underlying
are cheaper option.
» The proximity of K1 and K2 to ST will depend upon the Option
Premiums quoted and the trader’s view of volatility
With strangles strategy what happens if the price St falls below K1?
The Long Put is In-The-Money.
However, the Long Call is Out-of-the-Money.
With strangles strategy what happens if the price St rises above K2?
The Long Put is Out-of-the-Money.
However, the Long Call is In-the-Money.
What is a strip strategy?
A strip strategy involves creating a portfolio with Long
position in both a Put and a Call Options at the same
strike price but with more Puts than Calls.
» Like a straddle, this is Bullish on Volatility BUT it is
asymmetric – the expectation is that the price could move
either positively or negatively, but that it is more likely to be
negative. The expectation is that price volatility will be high.
» The proximity of K1 to ST will depend upon the Option
Premiums quoted and the trader’s view of price direction
and amount of volatility
With a strip strategy what happens if the St falls below K1?
The Long Puts are In-The-Money.
the Long Call is Out-of-the-Money.
With a strip strategy what happens if the price stays at or around K1?
The Long Puts are Out-of-the-
Money. The Long Call is Out-of-the-Money
With a strip strategy what happens if the price St rises above K1?
The Long Puts are Out-of-the-
Money.
the Long Call is In-the-Money
What is a strap strategy?
A strap strategy involves creating a portfolio with Long
position in both a Put and a Call Options at the same strike
price but with more Calls than Puts.
» Like a straddle, this is Bullish on Volatility BUT it is
asymmetric – the expectation is that there will be volatility
but that it is more likely to be positive. Therefore it is also
Bullish on Directional Volatility!
» The proximity of K1 to ST will depend upon the Option
Premiums quoted and the trader’s view of directional and
strength of volatility
With a strap strategy what happens if the St falls below K1?
The Long Put is In-The-Money.
the Long Calls are Out-of-the-Money.
With a straps strategy what happens if the price St stays at or around K1?
The Long Put is Out-of-the-Money
The Long Calls are Out-of-the-Money
With a straps strategy what happens if the price St rises above K1?
The Long Put is Out-of-the-Money.
the Long Calls are In-the-Money
With the Black-Scholes model what are the assumptions?
The price of the underlying follows a random walk (normal
distribution, think of week 3 case)
» No holding costs or benefits
» No taxes
» No transaction costs
» Everyone can borrow or lend at the risk-free rate indefinitely
