1. Trading Strategies Involving Options Chapter 10

2. Positions in an Option & the Underlying
Buy or sell call
Buy or sell put
buy or short sell stock
buy (lend at) or sell (borrow at) risk-free bond (rate)

3. Trading Strategies Involving Options
Take a position in the option & the underlying
Spread: Position in 2 or more options of the same type
Combination: Position in a mixture of calls & puts

4. Payoff for Put Option x
Cost = p
buy ST X
sell -X
Cost = -p

5. Payoff for Call Option x
Cost = c
buy ST X
sell
Cost = -c

6. Payoff for Stock
buy
Cost = S ST
sell
Cost = -S

7. Payoff for Investing or Borrowing PV(X) in Risk-Free Bond
Cost = Xe-rT X
buy ST
Cost = -Xe-rT -X
sell

8. Method Draw payoff pattern for each position
Add patterns together to obtain payout pattern
Determine cost of portfolio
Subtract cost of portfolio to obtain profit pattern

9. Write a Covered Call
buy stock X
Cost = S - c ST X
sell
call

10. Profit Pattern for Covered Call
Cost = S - c X
X-S+c ST X
-S+c
X-S+c

11. Payoff for Protective Put
Cost = S + p x ST X

12. Profit Pattern Protective Put
Cost = S + p x X ST
X-S-p
S+p

13. Bull Spread Buy 1 call and sell 1 call at higher strike buy ST sell
X2-X1
buy
Cost = c1 - c2 > 0 ST X1 X2
sell

14. Profit Pattern for Bull Spread
X2-X1 -c1+c2 ST
-c1+c2

15. Bear Spread Sell 1 call and buy 1 call at higher strike buy ST sell
Cost = c1 - c2 < 0 ST X2 X1
sell
X2-X1

16. Profit Pattern for Bear Spread
Cost = c1 - c2 < 0 ST X2 X1

17. Buy a Straddle Buy 1 call and 1 put at same strike X X Cost = c + p
payout
profit X
-p-c
X-p-c
X+p+c

18. Butterfly Spread
Buy 1 call at X1, sell 2 calls at X2, buy 1 call at X3
m = +1
m = -1 X2
m = 0 X1 X3
m = - 2
Cost = c1 - 2c2 + c3

19. Butterfly Spread Buy 1 call, sell 2 calls, buy 1 call X2-X1 payoff
cost
profit
Cost = c1 - 2c2 + c3

20. Bull Spread Using Calls
Figure 10.2
Profit X1 X2 ST

21. Bull Spread Using Puts
Figure 10.3 X1 X2
Profit ST

22. Bear Spread Using Calls
Figure 10.4 X1 X2
Profit ST

23. Bear Spread Using Puts
Figure 10.5 X1 X2
Profit ST

24. Butterfly Spread Using Calls
Figure 10.6 X1 X3
Profit ST X2

25. Butterfly Spread Using Puts
Figure 10.7 X1 X3
Profit ST X2

26. A Straddle Combination
Figure 10.10
Profit ST X

27. Strip & Strap
Figure 10.11
Profit
Profit X ST X ST
Strip
Strap

28. A Strangle Combination
Figure 10.12 X1 X2
Profit ST

29. Summary Write covered call: buy stock sell call
Protective put: buy stock and buy put
Bull spread: buy X1 call and sell X2 call
Bear spread: opposite of bull
Buy Straddle: buy X call and buy X put
Sell Straddle: opposite of buy straddle
Strangle: buy X1 put and buy X2 call
Butterfly spread: buy 1 X1 call, sell 2 X2 calls, and buy 1 X3 call