Lesson 17: Option Stategies Flashcards
Floors
own a stock -> insure the position by buying a put option of that stock -> this purchase: floor (guarantee a minimum sale price)
Caps
have a short position in a stock -> insure the position by buying a call option of that stock -> this purchase: cap (guarantee the maximum repurchasing price)
Naked writing
writer of the option does not have a position in the asset (not long/ short the stock)
Covered writing
writer of the option has a corresponding option in the underlying asset
Covered Call Writing
long the stock + simultaneously sell (write) a call option against the long position
Covered Put Writing
short the stock + simultaneously write (sell) a put option against the short position, short the stock + write a put option produces a profit diagram the same as written call
Parity equation
tells us the difference in the premiums of puts and calls, when the 2 options: same strike price and expiration time
Synthetic Forwards
mimic a long forward position = buying a call and selling a put, each option having the same strike price and time to expiration
Synthetic long forward vs actual long forward
- actual forward: 0 premium, synthetic forward: net option premium
- forward contract: pays forward price, synthetic forward: pays strike price
When strike price of synthetic forward = Forward price vs when not
- K = forward price -> C(S,K,T) - P(S,K,T) = 0 (K: the strike price of the option, S: stock price)
- K ≠ F: forward price -> C(S,K,T) -P(S,K,T) follows put- call parity
Put- call parity
C(S,K,T) - P(S,K,T) = Se^(-dividend rate * t) - Ke(^-risk free rate * t) = PV(F - K)
Off - market forward
forward contract for which the premium is not 0 (synthetic forward contract with option’s strike price K ≠ F: forward price)
Option spread
position consisting of only calls or only puts, in which some options are purchased and some written
Bull spread
- bull spread pays off if the stock moves up in price, but subject to a limit
- create bull spread with calls: buy K1 strike call, sell K2 strike call (K2 > K1)
- create bull spread with puts: buy K1 strike put and sell K2 put (K2 > K1)
Bear spread
- bear spread pays off the stock price moves down, but subject to a limit
- create bear spread with calls: buy K2 strike call, sell K1 strike call (K2 > K1)
- create bear spread with puts: buy K2 strike put and sell K1 put (K2 > K1)
Ratio spread
ratio spread involves buying n of 1 option and selling m of another option of the same type (m ≠ n)
Box spread
- a box spread: 4 option strategy consisting of buying a bull spread with strikes K1 and K2 ( K2>K1) and buying a bear spread with strikes K2 and K1 (bull and bear should be different types
- purpose of a box spread: financing arrangement, take advantage of a tax loophole
Collar
- a collar: purchase of a put and the sale of a call with higher strike price, both options have the same underlying asset and the same expiration date
- frequently used to implement insurance strategies
Collar Width
= call strike - put strike
Collared stock
- buying collar when we own stock -> collared stock
Zero - cost collar
- select strikes so that the net cost of the collar = 0
Speculating on Volatility
- Straddle
- Strangle
Straddle
- strategy: buying a call and a put with the same strike price and time to expiration
- pro: can profit from stock price moves in both directions -> buying straddle: a bet that volatility is greater than the market’s assessment of volatility
- cons: high premium cost
Strangle
- buy a put with strike price K1 and buy a call with strike price K2 with K1 < S < K2 (S: initial stock price)
Butterfly Spreads
written straddle with additional purchased options to limit the maximum loss
- Steps:
+ Purchase n bull spreads with strike prices K1, K2
+ Purchase m bear spreads with strike prices K3 and K2
+ K1<K2<K3
+ n and m are selected so that there are no pay off for St ≤ K1 or St ≥ K3
n/m = (K3 - K2) / (K2-K1)
-> option prices must be convex
