trading & hedging startegies involving options

8/7/2019 Trading & Hedging Startegies involving Options

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Trading & Hedging Strategies Using

Options

Group IV

Group Members

1.Manoj Jain (21)

2.Partha Mandal(27)

3.Prasant Verma(30)

4.Shy amal Das(40)

5.Soumy

aK

anti

Chow d

hury(41

)



2

Types of Trading Strategies

� Strategies Involving A Single Option and Stock .

� Spread Trading Strategy of taking a position intwo or more Options.

� Combination: Take a position in a mixture of

calls & puts (A combination)



Strategies Involving A Single

Option and Stock .

Profit

S T K

Profit

S T

K

Profit

S T

K

Profit

S T K

(a)Long

Position in

stock and

short

position ina call

(b) Short

Position

in a stock

with a

long

position ina call

(c) A Long

Position in

a Put with

a long

Position in

a stock

(d) A

short

Position

in a Putwith a

short

position

in a

stock



Bull Spread Using Calls

Spread Trading Strategy of taking a

position in two or more Options.

K 1

K 2

Profit

S T

Bull callSpread

involvesbuying a callwith a lowerstrike ( High

Premium)and selling a

call with ahigher strike

( low Premium)



Bull Spread Using Puts



K 1

K 2

Profit

S T

Bull Put

Spread

are

created

with in-

the-money

or out-of-

the money

put

options ,

all with

the same

expiry

date.



Bear Spread Using Puts



K 1

K 2

Profit

S T

Bear Put

Spread is

created when

higher strike

price ispurchased and

a lower strike

price is sold.

The options

should have the

same expiry

date.



Bear Spread Using Calls

Spread Trading Strategy of taking a position

in two or more Options.

K 1

K 2

Profit

S T

Bear call

Spread is

created when

call option is

sold at a lower strike price

while also

buying the

same number

of calls, but at a

higher strike

price. Theoptions should

have the same

expiry date.



Butterfly Spread Using

Calls

K 1

K 3

Profit

S T

K 2



Butterfly

Spread Using

Calls is

created by

buying a call

option with a

low strikeprice K1,

buying a call

option with a

high strike

price, K3 and

selling two

call optionswith a strike

price K2

halfway

between K1

and K3



Butterfly Spread Using Puts

K 1

K 3

Profit

S T

K 2



Butterfly

Spread Using

Puts is created

by buying a putwith a low

strike price,

buys a put with

a high strike

price, and sells

the two puts

with anintermediate

strike price.



A Straddle Combination

Profit

S T

K

Combination: Take a position in a mixture of


A Straddle

Combination

involves buyinga call and put

with the same

strike price and

expiration date.



A Strangle Combination

K 1

K 2

Profit

S T

Combination: Take a position in a mixture of


A StrangleCombination

is created by

buying one

call at a

higher strike

and one put at

a lower strikewith the same

expiry date.



Hedging Using Options

� Consider an inv estor who in Nov 2010 ow ns 1,500 Reliance shares

± The current share price is R s.1010 per share

� The

inv e

stor

is co

ncer

ne

dth

at the

sh

are pr

ice todecline sharply in the next two months and

w ants protection.

� The inv estor could buy 10 January put option

contracts w ith a strik e price of R s.1010 on NSE.± This would giv e the inv estor the right to sell 1,500

shares for R s.1010 per share.



Hedging Using Options ± contd.

� If the quoted option price is R s.25, each option contract would cost 150 x R s. 25 = R s. 3750, and the total cost of the hedging strategy would be 10

x R S. 3750 = R s. 37,500

� The strategy costs R s. 37,500 but guarantees

that the shares can be sold for at least Rs.1010 per share during the life of theoption.



Hedging Using Options ± contd.

� If the mark et price of Reliance f alls below R s. 1010, the options can be exercised so that R s. 15,15,000 is realized for the entire holding.

± W hen the cost of the options is tak en into account, theamount realized is R s.14,77,500

� If the mark et price stay s above Rs. 1010, theoptions are not exercised and expire worthless.

� Howev er, in this case the value of the holding is alw ay s abov e 15,15,000 (or abov e 14,77,500 if the cost of the options is tak en into account).



Speculation Using Options

� Suppose that it is October and a speculator considersthat Cisco is likely to increase in value ov er thenext two months.

± The stock price is currently $20, and a two-month call option

w ith a $25 strik e price is currently selling for $1.� The speculator is w illing to invest $4,000.

� It has two alternatives± The f irst alternativ e inv olv es the purchase of 200 shares

± The second inv olv es the purchase of 4,000 call options (i.e., 20

call option contracts)

� Suppose that the speculator's hunch is correct and theprice of Cisco's shares rises to $35 by December.



Speculation Using Options ± contd.

� The f irst alternativ e of buy ing the stock y ields a prof it of 200 x ($35 - $20) = $3,000

� Howev er, the second alternative is far moreprofitable.

� A call option on Cisco w ith a strik e price of $25 giv es a payoff of $10, because it enables something worth $35 tobe bought for $25.

± The total payoff from the 4,000 options that are purchased under the second alternativ e is:

4,000 x $10 = $40,000± Subtracting the original cost of the options y ields a net prof it of

$40,000 - $4,000 = $36,000

� The options strategy is, therefore, 12 times as prof itableas the strategy of buy ing the stock.



Speculation Using Option ± contd.

� Options also giv e rise to a greater potential loss.

� Suppose the stock price falls to $15 by December± The f irst alternativ e of buy ing stock y ields a

loss of 200 x ($20-$15) = $1,000.

± Because the call options expire w ithout beingexercised, the options strategy would lead to a loss of $4,000²the original amount paid forthe options.

trading & hedging startegies involving options

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