Option Strategies

Question 1

hedging equity portfolio

Answer 1

concerned about rising volatility in the equity market, a strategy to mitigate risk

Question 2

Portfolio insurance strategies

Answer 2

holding more cash, diversification, sell or hedge an individual security, buying equity put option

Question 3

disadvantages of portfolio hedging

Answer 3

put options can be expensive to purchase, option time value declines (time decay) rapidly as expiry approaches, mismatch between portfolio and instrument used to hedge, daily mark-to-market of options can increase volatility

Question 4

key features of portfolio insurance

Answer 4

• its a trading strategy supposed to protect investors portfolios against market declines
• this strategy guarantees a floor value of the portfolio in exchange for the advance payment of insurance premium, similar to buying put option
• investors could combine the investments in the underlying equities with the insurance strategy to create a protective put which forms a floor on the value of the portoflio
• this combination is not static and would require constant re balancing in process called dynamic hedging

Question 5

long call option

Answer 5

• the buyer expects the underlying price will go up and buys a call option if,if the option is OTM, the option is abandoned and he/she will lose the premium
• investor may think he might not be able to afford the option premium, could finance a long call position by selling another call option at a higher strike price

Question 6

bear spread

Answer 6

• when you expect the underlying price S to go down, you could buy a put option.
• the put option can be expensive, thus you could finance this position by selling another put option at lower strike price

Question 7

straddle

Answer 7

• previous trades require a view on a particular direction of the security, what happens if you are unsure about the direction but expect a big move in the underlying price to happen
• you use a straddle, a combo of a long position in the call and put option with the same strike price K and expiry date

Question 8

collar

Answer 8

involves a long position in the underlying, a put option at a lower strike price and a short call position at a higher strike price