Week 3: trading strategies involving options Flashcards
What are the 4 option trading strategies?
- 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)
What position does the principal protected note (PPN) allow investors to take?
- Allows investor to take a risky position without risking any principal
give an example of a PPN
Example: $1000 investment 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
It means the strike price is $1,000 (ST = K)
(PPN) how is the principal protected?
it is protected by the bond as you will always get the principal payment from the bond at maturity
what is a protective put?
when you have a long position in a stock and a long put
(Protective Put)
What happens if ST > K?
- Payoff = 0 + ST = ST,
- Profit = ST - p
(Protective Put)
What happens if ST < K?
- Payoff = K - ST + ST = K,
- Profit = K - p =>fixed
(Protective Put)
What does it protect the investor from?
From a loss on the stock if the stock drops sharply
what comprises the opposite of a protective put?
a short position in a stock plus a short put
(Opposite of Protective Put)
What happens if ST > K?
- Payoff = 0 -ST = -ST,
- Profit = -ST+p
=> profit decreases as ST increases
(Opposite of Protective Put)
What happens if ST < K?
- Payoff = -(K - ST) - ST = -K,
- Profit = -K + p
=>fixed
what does writing a covered-call comprise of?
A long position in a stock plus a short position in a call option
(writing a covered-call)
what happens if ST > K?
- Payoff = - (ST - K) + ST = K,
- Profit = K + c
=> fixed
(writing a covered-call)
What happens if ST < K?
- Payoff = 0 + ST = ST,
- Profit = ST + c
=> profit decreases as ST decreases below K
What does writing a covered-call protect the investor from?
=> Protects the investor from the payoff on the short call that is necessary if the
stock rises sharply.
