option strategies corporate

7/30/2019 Option Strategies Corporate

1/23

Options Strategies

By Vaibhav KabraM.F.S.M, F.R.M.


2/23

Options & Strategies

1

Option:

An option is an agreement between two parties for a specified time period (up to the expiry date) that gives the holder the right, not theobligation, to buy or sell a specified number of shares, usually a lot of 100, at a pre-determined price (exercise or strike price). You can

buy and sell options just like shares.

When the option is acquired, the buyer of the option (holder) pays a premium (price of the option) to the seller (writer). The holder thus

obtains the right to decide what happens. The writer must abide by the decision of the holder. It is important to understand that an

option contract is simply a right on the part of the buyer and an obligation on the part of the writer to transact at a future date.

Types: There are two types of options, options to buy (call options) and options to sell (put options).

Strike price: The strike price is the price at which the option holder can buy (or sell) the shares. If you hold a call option on ABC Inc.

at a strike price of $50.00, you can exercise the option and pay only $50.00 per share even if the stock is trading at a higher price.

Premium: The premium is the price of the option, i.e. the amount the buyer pays to the seller for the right of the option. The premium

is not a down payment on a future stock purchase. The seller keeps the premium even if the option is not exercised. The option holder

pays a premium and hopes to make a profit by reselling the option or exercising it. The option writer, on the other hand, considers the

premium he receives from the buyer as a source of additional income or as protection. He receives the premium as compensation for the

risks he assumes in agreeing to honour the option terms.

Intrinsic value of options: The intrinsic value of a call option is the difference between the price of the underlying stock and the option

strike price. A positive intrinsic value means that the option is currently in-the-money. An intrinsic value of or near zero means that the

option is at-the-money. By definition, the intrinsic value cannot be negative. A negative intrinsic value (we say that it has no value)

means that the option is out-of-the-money.


3/23

Time value of options: The time value of an option is the portion of the option premium that is attributable to the amount of time

remaining until the expiration of the option contract. Time value is the difference between the option premium and its intrinsic value.

The factors that strongly impact the time value are the volatility of the underlying stock, the remaining time to expiry, the dividends

paid out during the life of the option, the risk-free interest rates, and the supply and demand for the option (implied volatility).

Components that influence option premiums:

Market dynamics influence option premiums in different ways. It is essential to understand these dynamics in order to evaluate the

impact of variations of certain components on the value of options. Following are the six components that affect the value of options.

Underlying stock price: The market price of the stock underlying a particular option is the most important determinant ofoption premiums because if the stock price is much higher or much lower than the strike price, the effect of other components will be

very small. In general, the relationship of a call option premium to the price of the underlying stock is quite simple. If the price of the

stock rises, the call option premium will tend to rise, all else being equal. Conversely, the premium of a put option tends to rise as the

value of the underlying share declines. The higher the stock price, the greater the value of a call option and the lower the value of a put

option.

Strike price: In the case of call options, the higher the strike price compared to the stock price, the lower the value of the option. In the

case of put options, the higher the strike price compared to the stock price, the greater the value of the option.

Time to expiry: Generally, the more time remaining before an option expires, the higher the premium. It is quite logical when we recall

that option writers demand larger premiums when they perceive their risks to be greater. For example, the premium for a December

option contract on a particular stock is higher than the premium for a September contract on the same stock because the December

option gives three additional months during which the price of the stock can go up or down.



4/23

Stock price volatility: The more volatile the price of the underlying stock, the higher the price of both the call and the put

options. Why? Because the greater the volatility, the greater the fluctuation in the stock price, hence the greater the likelihood that each

option will be deeply in-the-money on the expiry date. Similarly, stock option premiums in general will rise if overall stock market

conditions are more volatile.

Risk-free interest rates: Interest rates during the life of an option have the opposite effect on the price of call and put options. High

interest rates tend to drive up the premium of call options (all else being equal) and drive down the premium of put options. However,

studies have shown that changes in interest rates have little effect on the options price. When interest rates are high, investors prefer to

buy call options rather than the actual shares (because less investment is required) and invest the rest of their money in fixed income

instruments offering a higher return. This significant advantage of call options during periods of high interest rates will result in higher

call option premiums, as the call options become more attractive to investors. The cost of carry of an equivalent stock position at

short-term rates will, therefore, be built into the premium.

Anticipated dividends during the life of the option: Since the stock price will generally decrease by the amount of the dividend (after

the ex-dividend date), the call option on the stock will necessarily be worth less. Therefore, imminent dividend payments are reflected

in lower call option premiums. Conversely, since the price of the underlying stock will

generally decrease by the amount of the dividend, and put premiums rise as the stock price falls, the put premium will reflect the

anticipated drop in the stock price.



5/23

Sr. No Strategies Objectives

1 Long Call Understanding Option Strategies

2 Short Call How it is used / Implementation

3 Long Putt When it is used / Outlook

4 Short Putt Understanding PayOff Diagrams

5 Covered Call

6 Protective Putt

7 Bull Spread

8 Bear Spread

9 Long Straddle

10 Short Straddle

11 Long Strangle

12 Short Strangle

13 Long Strip14 Short Strip

15 Long Strap

16 Short Strap

17 Long Butterfly

18 Short Butterfly

Strategies



6/23

Mkt Price Premium Call Putt Profit / Loss

90 -10 - - -10100 -10 - - -10

105 -10 100 - -5

110 -10 100 - 0

130 -10 100 - 20

150 -10 100 - 40

Strike Price 100Premium 10

Long Call: A Bullish Strategy wherein an option to Buy' (Call)

is 'Purchased' presuming that the price of the underlying is going

to increase in the future & hence to hedge against such rise in

price this option is bought to buy the underlying at the predecided price StrikePrice on a certain Future Date.

Important Points:

Outlook: Bullish

Max Profit: Unlimited

Max Loss: Limited to premium paid

Motivation: Expectation is that the price of the underlying is

going to rise in the future, so to hedge against it, the price is

fixed at a particular strike price at which it would be purchased

at a future date.

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call


7/23

Short Call: A Bearish Strategy wherein an option to 'Buy (Call)

is 'Sold' presuming that the price of the underlying is not going to

increase or will decrease in the future. Here as the outlook is

bearish the option to buy "Call" is sold thinking that it would notbe exercised & premium can be earned in return.

Important Points:

Outlook: Bearish

Max Profit: Premium Received

Max Loss: Unlimited


going to fall in the future, so a Call is sold at a Strike Price above

which the price of the underlying is not expected to go & hence

earning a premium.


90 10 - - 10100 10 - - 10

105 10 100 - 5

110 10 100 - 0

130 10 100 - -20

150 10 100 - -40


Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call


8/23

Long Putt: A Bearish Strategy wherein an option to 'Sell' is

'Purchased' presuming that the price of the underlying is going to

decrease in the future. Hence to hedge against the risk of fall in

price this option is bought to sell the underlying at a the predecided price StrikePrice on a certain Future Date.

Important Points:

Outlook: Bearish

Max Profit: Limited & Maximum when Mkt Price = 0.

Max Loss: Limited to premium paid.


going to fall in the future, so to hedge against it, the price is fixed

at a particular strike price at which it would be sold at a future

date irrespective of its Mkt Price.

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40


70 -10 - 100 2090 -10 - 100 0

95 -10 - 100 -5

100 -10 - - -10

110 -10 - - -10

130 -10 - - -10


Long Putt


9/23

Short Putt: A Bullish Strategy wherein an option to 'Sell' is

'Sold' presuming that the price of the underlying is not going to

decrease or will increase in the future. Here as the outlook is

bullish the option to sell "Putt" is sold thinking that it would notbe exercised & premium can be earned in return.

Important Points:

Outlook: Bullish

Max Profit: Limited to the premium received.

Max Loss: Limited & Maximum when Mkt Price = 0.


going to rise in the future, so a Putt is sold at a strike price below


earning a premium.


70 10 - 100 -2090 10 - 100 0

95 10 - 100 5

100 10 - - 10

110 10 - - 10

130 10 - - 10


Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Putt


10/23

Covered Call: A strategy in which you possess the stock & dont

want to sell it in short term. So, you sell the option to buy on the

same stock (Short Call) assuming that price of the underlying is

not going to rise in short term & hence to benefit from thepremium received.

Important Points:

Outlook: Bearish


Max Loss: Unlimited

Motivation: Expectation is that the price of the underlying is not

going to rise in the future, so a Call is sold at a strike price above


earning a premium.


90 -10 - - 10100 -10 - - 10

105 -10 100 - 5

110 -10 100 - 0

130 -10 100 - -20

150 -10 100 - -40


Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Stock

Call

Profit/Loss

Covered Call


11/23

Protective Putt: A strategy in which you possess the stock &

think that its price will rise in the long term but want to hedge

against the fall in the price of the same, so you buy the option to

sell ( Long Putt)

Important Points:

Outlook: Bearish

Max Profit: Limited & Maximum when Mkt Price = 0.Max Loss: Limited to premium paid.


going to rise in the future, but as the underlying is possessed

physically, investor wants to hedge against the fall in prices &

hence a Putt option is bought.


70 -10 - 100 2090 -10 - 100 0

95 -10 - 100 -5

100 -10 - - -10

110 -10 - - -10

130 -10 - - -10


Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Stock

Put

Profit/Loss

Protective Putt


12/23

Bull Spread: A strategy in which Option to buy is bought

(Long Call) & sold (Short Call) but at a diff. strike price.

Investor thinks that market will not fall but wants to limit his

risk by getting the premium on Call sold.

Important Points:

Outlook: Bullish

Max Profit: At Higher Strike Price.

Max Loss: Limited to the difference in premium.


going to rise in the future, so a Call is purchased. Investor also

wants to cover the premium loss on Long Call, so he sells one

Call at a Strike Price above which the price of the underlying is

not expected to go & hence also covering for the premium paid.

Mkt Price Premium Long Call Short Call Profit / Loss

90 -3 - - -3100 -3 - - -3

103 -3 100 - 0

110 -3 100 - 7

120 -3 100 - 17

130 -3 100 120 17

Strike Price (Long Call) 100

Strike Price (Short Call) 120

Premium (Long Call) 10Premium (Short Call) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call

Short Call

Overall Profit

Bull Spread


13/23

Bear Spread: A strategy in which Option to sell is bought (Long

Putt) & sold (Short Putt) but at a diff. strike price. Investor thinks

that market will not rise but wants to limit his risk by getting the

premium on Putt sold. Maximum Profit on Lower Strike price.

Important Points:

Outlook: Bearish

Max Profit: At Lower Strike Price.

Max Loss: Limited to the difference in premium.


going to fall in the future, so a Putt is purchased. Investor also

wants to cover the premium loss on Long Putt, so he sells one

Putt at a Strike Price below which the price of the underlying is

not expected to go & hence also covering for the premium paid.

Mkt Price Premium Long Putt Short Putt Profit / Loss

80 3 120 100 1790 3 120 100 17

100 3 120 - 17

110 3 120 - 7

117 3 120 - 0

130 3 - - -3

Strike Price (Long Putt) 120

Strike Price (Short Putt) 100

Premium (Long Putt) 10Premium (Short Putt) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Put

Short Put

Overall Profit

Bear Spread


14/23

Long Straddle: A strategy in which both option to buy & sell

are bought at same strike price (Long Call & Long Putt).

Investor is expecting market to be very volatile.

Important Points:

Outlook: Very Volatile



Motivation: Expectation is that the market would be very

volatile & investor does not have any clue about the direction in

which its going to go. Hence he purchases a Call as well a Putt.

But in this case it is to be noted that premium for this strategy is

very high as the buyer of the option can always exercise the

option whether market moves up or down as he has purchased

both Call & Putt.

Mkt Price Premium Long Call Long Putt Profit / Loss

70 -17 - 100 1383 -17 - 100 0

100 -17 - - -17

110 -17 100 - -7

117 -17 100 - 0

150 -17 100 - 33

Strike Price 100

Premium (Long Call) 10

Premium (Long Putt) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call

Long Put

Overall Profit

Long Straddle


15/23

Short Straddle: A strategy in which both option to buy &sell are sold at same strike price (Short Call & Short Putt).

Investor is expecting market to be very stable.

Important Points:

Outlook: Stable



Motivation: Expectation is that the market would bestable & hence both Call & Putt are sold for a very high

premium charged. Here it is expected that market would

not move drastically in any direction & hence premium can

be earned by selling Call & Putt.

Mkt Price Premium Short Call Short Putt Profit / Loss

70 17 - 100 -1383 17 - 100 0

100 17 - - 17

110 17 100 - 7

117 17 100 - 0

150 17 100 - -33

Strike Price 100

Premium (Short Call) 10

Premium (Short Putt) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call

Short Put

Overall Profit

Short Straddle


16/23

Long Strangle: This strategy is same as Long Straddle. The only

difference being Different Strike prices for Long Call & Long

Putt. Premium charged here is less than Long Straddle as the

seller of the option has better chance of staying In the Money dueto gap b/w two Strike Prices.

Important Points:




Motivation: Motivation behind this strategy is same as Long

Straddle. The only difference is that the strike price for Long

Call & Long Putt is different. Due to this seller of the option has

better chance of staying in the money, and hence premium

charged on this is relatively lower than Straddle. Also for the

Buyer to exercise this option, price of the underlying will have tomove drastically for him to be in the money.

Mkt Price Premium Long Call Long Putt Profit / Loss

70 -17 - 100 1383 -17 - 100 0

100 -17 - - -17

110 -17 - - -17

137 -17 120 - 0

150 -17 120 - 13

Strike Price (Long Call) 120

Strike Price (Long Putt) 100



Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call

LongPut

Overall Profit

Long Strangle


17/23

Short Strangle: This strategy is same as Short Straddle. The

only difference being Different Strike prices for Short Call &

Short Putt. Premium charged here is less than Short Straddle as

the seller of the option has better chance of staying In the Moneydue to gap b/w two Strike Prices.

Important Points:

Outlook: Stable



Motivation: Motivation behind this strategy is same as Long

Straddle. Here it is expected that market would not move

drastically in any direction & hence premium can be earned by

selling Call & Putt. Premium earned here would be less than

Straddle as seller has better chance to be in the money in this

option.

Mkt Price Premium Short Call Short Putt Profit / Loss

70 17 - 100 -13

83 17 - 100 0

100 17 - - 17

110 17 - - 17

137 17 120 - 0

150 17 120 - -13


Strike Price (Short Putt) 100

Premium (Short Call) 10Premium (Short Putt) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call

Short Put

Overall Profit

Short Strangle


18/23

Long Strip: A strategy in which 1 Call & 2 Putts are bought.

Investor thinks that market would be volatile but is more likely

to fall.

Important Points:

Outlook: Volatile & Slightly Bearish

Max Profit: Limited & maximum when Mkt Price = 0 for Putt

& Unlimited for Call.

Max Loss: Limited to the premium paid.

Motivation: Expectation is that the market will be volatile but

price of the underlying is more likely to fall than rise in the

future, so 2 Putt options are bought to hedge against the fall in

the prices. A Call option is also bought to hedge against the

volatility in the market. Investor buys 2 Putt options & 1 Call

option as price of the underlying is more likely to fall than rise

in the future.

Mkt Price Premium Long Call Long Putt (2) Profit / Loss

70 -24 - 100 3688 -24 - 100 0

100 -24 - - -24

110 -24 100 - -14

124 -24 100 - 0

150 -24 100 - 26

Strike Price 100



Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call

Long Put(2)

Overall Profit

Long Strip


19/23

Short Strip: A strategy in which 1 Call & 2 Putts are sold.

Investor thinks that market would be stable and is more likely

to rise.

Important Points:

Outlook: Stable & Slightly Bullish


Max Loss: Limited & Maximum when Mkt Price = 0 for Putt& Unlimited for Call.

Motivation: Expectation is that the price of the underlying

would not change much as it is expected that market would be

stable. If it does change in the future its more likely to rise

than fall and hence 1 Call option & 2 Putt options are sold.

Mkt Price Premium Short Call Short Putt (2) Profit / Loss

70 24 - 100 -36

88 24 - 100 0

100 24 - - 24

110 24 100 - 14

124 24 100 - 0

150 24 100 - -26

Strike Price 100


Premium (Short Putt) 7

Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call

Short Put(2)

Overall Profit

Short Strip


20/23

Long Strap: A strategy in which 1 Putt & 2 Calls are bought.

Investor thinks that market would be volatile but is more

likely to rise.

Important Points:

Outlook: Volatile & Slightly Bullish

Max Profit: Unlimited for Calls & Limited & maximum

when Mkt Price = 0 for Putt.

Max Loss: Limited to the premium paid.

Motivation: Expectation is that the market will be volatile but

price of the underlying is more likely to rise than fall in the

future, so 2 Call options are bought to hedge against the rise in

the prices. A Putt option is also bought to hedge against the

volatility in the market. Investor buys 2 Call options & 1 Putt

option as price of the underlying is more likely to rise than fall

in the future.


70 -24 - 100 36

88 -24 - 100 0

100 -24 - - -24

110 -24 100 - -14

124 -24 100 - 0

150 -24 100 - 26

Strike Price 100



Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Call (2)

Long Put

Overall Profit

Long Strap


21/23

Short Strap: A strategy in which 1 Putt & 2 Calls are sold.

Investor thinks that market would be stable and is more likely

to fall.

Important Points:

Outlook: Stable & Slightly Bearish


Max Loss: Unlimited for Calls & Limited & maximum whenMkt Price = 0 for Putt.

Motivation: Expectation is that the price of the underlying

would not change much as it is expected that market would be

stable. If it does change in the future its more likely to fall

than rise and hence 1 Putt option & 2 Call options are sold.


70 -24 - 100 36

88 -24 - 100 0

100 -24 - - -24

110 -24 100 - -14

124 -24 100 - 0

150 -24 100 - 26

Strike Price 100



Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call (2)

Short Put

Overall Profit

Short Strap


22/23

Long Butterfly: A strategy in which 1 Call Option is

bought at a High Strike Price & 1 at a Low Strike

Price & 2 Call Options are sold at a Strike Price

which is b/w the High Strike Price & Low StrikePrice. Investor expects market to be very Volatile &

doesnt know the direction in which its heading.

Important Points:

Outlook: Very VolatileMax Profit: Limited & maximum at the strike price

at which 2 Calls are sold.

Max Loss: Limited to the difference of premium

paid & received.

Motivation: Expectation is that the market would be

very volatile & investor does not want to take any

risk is such situation. So he enters in to this strategy

where both Profit & Loss is limited & investor has

an idea of the maximum loss that can be suffered.

This is low risk, low return strategy. Investors

position is perfectly hedged against volatility in this

strategy but this is also very difficult to implement.

Mkt Price Premium

Long Call

(100)

Short Call

(120)

Long Call

(140) Profit / Loss

100 -3 - - - -3

103 -3 100 - - 0115 -3 100 - - 12

120 -3 100 - - 17

130 -3 100 120 - 7

160 -3 100 120 140 -3

Strike Price (Long Call 1) 100


Strike Price (Long Call 2) 140Premium (Long Call 1) 15


Premium (Long Call 2) 8

Example:

Long Call (15)

Long Call (35)

2 Short Call (25)

Overall Profit

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Long Butterfly


23/23

Short Butterfly: A strategy in which 1 Call Option

is sold at a High Strike Price & 1 at a Low Strike

Price & 2 Call Options are bought at a Strike Price

which is b/w the High Strike Price & Low StrikePrice. Investor expects market to be very Volatile &

doesnt know the direction in which its heading.

Important Points:


Max Profit: Limited & maximum at the strike priceat which 2 Calls are purchased.

Max Loss: Limited to the difference of premium

paid & received.

Motivation: Expectation is that the market would be

very volatile & motivation is very similar to Long

Butterfly, the difference is just in the

implementation of the strategy. Here he sells a Call

at High & Low Strike prices each & buys 2 Calls ata Strike Price b/w High 7 Low Strike Price which is

vice versa in Long Butterfly.

Mkt Price Premium

Long Call

(100)

Short Call

(120)

Long Call

(140) Profit / Loss

100 -3 - - - -3

103 -3 100 - - 0

115 -3 100 - - 12

120 -3 100 - - 17

130 -3 100 120 - 7

160 -3 100 120 140 -3







Example:

-30

-25

-20

-15

-10

-5

0

5

10

15

20

25

30

0 5 10 15 20 25 30 35 40

Short Call (15)

Short Call (35)

2 Long Call (25)

Overall Profit

Short Butterfly

option strategies corporate

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