1. Lecture 4

2. Bullish StrategiesRiskReward Call purchaselimitedunlimited Synthetic long stockunlimitedunlimited Bull spreadlimitedlimited Protective Putlimitedunlimited Bullish calendar spreadlimitedunlimited Covered callunlimitedlimited Naked put writeunlimitedlimited

3. Bearish StrategiesRiskReward Put purchaselimitedunlimited Synthetic Putlimitedunlimited Synthetic short saleunlimitedunlimited Bear spreadlimitedlimited Covered put writeunlimitedlimited Bearish calendar spreadlimitedunlimited Naked call writeunlimitedlimited

4. Long Stock, Short Call

5. Profit = S + call - P BE = P - call

6. Long Stock, Long Put

7. Profit = P - put - S

8.  Short Stock, Long Call

10.  Short Stock, Short Put

12.  Short Put, Long Call

15.  Long Call @ s1 s1 < s2  Short Call @ s2  Max Profit = s2 - s1 - c1 + c2  Break Even = s2 - MP = s1 - c2 + c1

16. Example Price = 32Oct35C = 1t=60days/365 Oct30C = 3v =.24 Buy Oct30C = -3 Sell Oct35C = +1 Max Profit = 35-30-3+1 = 3 BE = 30-1+3 = 32 Net Debit = -3 + 1 = -2

21.  Profit / Loss Diagram Table

22.  Compute probability of bull spread Example V t =.24 (60/365).5 =.097 Prob (<32) = N[ln(32/32) /.097] =.5000 Prob (>32) = 1 -.500 =.5000 Max Profit = $300 Max Loss = -$200 at 50% odds, makes good sense

24.  s1 < P << s2  Good probability, good profit potential

25.  P < s1 < s2  Small Cost, high profit, low prob

26.  S1 < s2 < P  Low profit, high prob

27. Long Put @ s1 s1 < s2 Short put @ s2 example (Credit Spread) Price = 55 Jan50P = 2 Jan60P = 7 Net Credit = p2 - p1 = + 7 - 2 = + 5 Break Even = S2 - credit = 60 - 5 = 55

31. Short Call @ s1 s1 < s2 Long Call @ s2credit spread

32. Short Call @ s1 s1 < s2 Long Call @ s2credit spread Example P = 55Jan60C = 2Jan50C = 7 Net Credit = 7 - 2 = 5BE = 50 + 5 = 55

33. Short Call @ s1 s1 < s2 Long Call @ s2credit spread Example P = 55Jan60C = 2Jan50C = 7 Net Credit = 7 - 2 = 5BE = 50 + 5 = 55

34. Long Put @ s1 s1 > s2 Short Put @ s2debit spread

35. Long Put @ s1 s1 > s2 Short Put @ s2debit spread Example P = 55Jan50P = 2Jan60P = 7 Net Debit = 7 - 2 = 5BE = 60 - 5 = 55

36. Long Put @ s1 s1 > s2 Short Put @ s2debit spread Example P = 55Jan50P = 2Jan60P = 7 Net Debit = 7 - 2 = 5BE = 60 - 5 = 55

37. +Credit spread - assignment risk ? What causes assignment -Large Credit = P well above lower strike Example: p = 59, Jan60C=1, Jan50C=9

38. Long Stock, Long Call, Short 2 Calls Example Own stock @ $48 Price = 42 Oct40Call = 4 (buy) Oct45Call = 2 (sell 2) Net Credit = 0 BE = 44

44. PriceP/LStP/L Sh CP/L Lg CNet P/L 35-1300+400-400-1300 38-1000+400-400-1000 40-800+400-400-800 42-600+400-200-400 44-400+40000 45-300+400+100+200 480-200+400+200 50+200-600+600+200

45. If call is deep in the money and has no time to exp, a bull spread can be used to simulate a covered call. Example Price = 49 Sell Apr50C = 3 Buy Apr35C = 14

47. A neutral position that combines both a bear spread and a bull spread Long call @ s1s1 < s2 < s3 Short 2 calls @ s2 Long call @ s3 Example Price = 60 buy July50C = 121200 debit short2 July60C = 61200 credit buy July70C = 3 300 debit 300 Net Debit

52. Multiple ways to create the butterfly spread example Strike506070 Call1262 Put1511 Butterfly PositionsNet Position Buy 50C / sell 2 60C / buy 70C2 debit Buy50C/sell 60C/buy70P/sell60P12 debit Buy50P/sell60P/Buy70C/sell60C8 credit Buy50P / sell 2 60P / buy 70P2 debit

53. Long stock, short multiple calls example 2:1 ratio call write Price = 49 Oct50C = 6 sell 2 calls and long 100 stock

55. example 2:1 ratio call write Price = 49 Oct50C = 6 sell 2 calls and long 100 stock Price drops to 40 Oct50C = 1 Oct40C = 4 Buy 2 Oct50C = profit = 12 - 2 = 10 Sell 2 Oct40C apply to stock price & pretend we own stock at $39

57. Max Profit = m(S-P) + nCm = # stock lots Upside BE = S + MP/(n-m)n = # of Call ks Downside BE = S - MP / m Example Max Profit = 1 (50-49) + 2 (6) = 13 Upside BE = 50 + 13/ (2-1) = 63 Downside BE = 50 - 13/1 = 37

58. Example 3:1 Buy 1 lot stock @ 49 sell 3 oct50c@18 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = 50 + 19/ (3-1) = 59.5 Downside BE = 50 - 19/1 = 31

59. Example 3:1 Buy 1 lot stock @ 49 sell 3 oct50c@18 Max Profit = 1 (50-49) + 3 (6) = 19 Upside BE = 50 + 19/ (3-1) = 59.5 Downside BE = 50 - 19/1 = 31

60. Long stock, s1 < P < s2 short in money call (s1), short out of money call (s2) Max Profit = c1 + c2 + s1 - P Downside BE = s1 - MP Upside BE = s2 + MP Example Price = 65 Oct60C = 8 Oct70C = 3

64. Don’t do - because

65. Long call @ s1s1 < s2 Short X calls @ s2 Example 2:1 Price = 44 Apr40C = 5buy 1 Apr45C = 3sell 2 BE = 51 MP = 6

66. Step 1

67. Step 2

70. 3:1 example increase profit lower BE 2:1

71. 3:1 example increase profit lower BE 3:1

72. Short Put Short Call Example Price = 45 Jan45C = 4 Jan45P =3

73. Same Example - But, sell 4 of each Price = 45 Jan45C = 4 Jan45P =3

74. Long Stock Short Call Short Put example Price = 51buy 100 shares Jan50C = 5sell 1 call Jan50P = 4sell 1 put Max Profit = Premium + S - P = 9 + 50 - 51 = 8 BE = (P+S-Prem)/2 = 46

77. Short put (out of money) Short call (out of money) example price = 65 Jan70C = 4 Jan60P = 3 Downside BE = Sp - put - call = 60-3-4 = 53 Upside BE = Sc + put + call = 70+3+4 = 77 Max Profit = put + call = 3+4 = 7

79. same example price = 65 (price rises to 70) Jan70C = 4 Jan60P = 3Put falls to 1 Jan70P = 4 action: buy back the 60 put & sell the 70 put

83. Short out of money put Long out of money call example (Bullish Strike Split) price = 53 Jan50P = 2 Jan60C = 1 BE = 48

86. Short near term option Long distant term option example (Bull Calendar Spread) Price = 50 TodayApr50C = 5 short = +5 (Jan) July50C = 8 long = -8 Net Debit = -3 Price = 50 AprilApr50C = 0 July50C = 5

89. Price Apr50C/PLJuly50C/PLNet Profit 400/+500.5/-750-250 450/+5002.5/-550-50 480/+5004/-400+100 500/+5005/-300+200 522/+3006/-200+100 555/08/00 6010/-50010.5/+250+250

90. Same as call short near term & long distant term ex - price = 50, Jan50P = 2, Apr50P = 3

91. Opposite of all other common positions Example (Reverse ratio - backspread) 2:1 Short call @ s1 s1<s2 Long x calls @ s2 Price = 43 July40C = 4 July45C = 1

92.  Step 1

95. diff strikes & diff exp example (Diagonal Bull Spread) Price = 32 Apr30C = 3 Apr35C = 1 July30C = 4Long July30C July35C = 1.5Short Apr35C Normal Bull Spread -Long Apr30C Short Apr35C