Derivatives

FIN 334

Professor Imerman
Spring 2015

DerivaLab #2: Option Trading Strategies

(Due: March 4, 2015)
The purpose of todays Derivatives Lab is to construct, price, and simulate some trading
strategies involving options on your chosen stock. It will require that you collect some updated
data for several option contracts on your stock; ideally you will select contracts with April 2015
expiration dates, although May 2015 maturities should work just as well.
This document is organized as follows: first, you will find the Assignments associated with this
Lab; then, there are some instructions for how to find and collect the necessary data and
construct the trading strategies; finally, there are some Discussion Questions that must be
addressed in your Lab Report.
The deliverables are as follows:
typed Lab Report (1 per group)
printouts of your data and analysis in Excel (one version with numerical output
and the other with formulas)
o This includes tables and plots for your payoffs and P&L
Assignment:
A. Construct either a bull spread with call options OR a bear spread with put options
B. Construct a butterfly spread using 4 call options [with 3 different strike prices]
C. Construct a long straddle with call and put options
D. Construct either a strip OR a strap
For each of the strategies (A, B, C, D) you will simulate the payoff for different terminal
stock prices in Excel and plot the payoff diagram. You will also use Bloomberg to price
each of the strategies and provide some analysis. Details given below.
Bloomberg Instructions:
After logging-on to the Bloomberg, enter your ticker, hit the [Equity] key (F8), enter OMON,
and hit <GO>. This will take you to the Option Monitor screen for your stock. Select April
2015 under Expiry (97 at the top of the screen) and set Strikes to 7, centered around the current
stock price (should be default). As with the previous DerivaLab, this will give you an option
chain of 3 OTM, 1 ATM, and 3 ITM call and put options for your stock that expire in April
2015. These will most likely be all of the contracts you will need to construct your strategies.
You might want to download this to Excel just so you have the prices, to which you may need to
refer when pricing your strategies. To download, go to Actions (96 at the top of the screen) and
select Export to Excel. Save to your H drive or memory stick.

Derivatives
FIN 334

Professor Imerman
Spring 2015

Then immediately proceed to the Option Valuation screen by typing OVL + <GO>. This is
where you will be able to construct and price your strategies as follows:
A. Bull call spread / Bear put spread
Select the [] next to where it says American Vanilla on the left hand side of the
Option Valuation screen.
Option Strategies
Call/Put Spread (CP)
Select which option you are Long vs. Short, K1 & K2, and make sure you have
the right Expiry (April 2015)
Note the Total Price for the strategy
B. Butterfly spread
Select the [] next to where it says American Vanilla on the left hand side of the
Option Valuation screen.
Option Strategies
Butterfly Spread (BFS)
Select the options that you buy -- 1 @ K1 and 1 @ K3 and the options you sell: 2 @
K2, and make sure you have the right Expiry (April 2015)
Note the Total Price for the strategy

C. Straddle
Select the [] next to where it says American Vanilla on the left hand side of the
Option Valuation screen.
Option Strategies
Straddle (SD)
Select your strike price and make sure you have the right Expiry (April 2015)
Note the Total Price for the strategy
D. Strip/Strap
Select the [] next to where it says American Vanilla on the left hand side of the
Option Valuation screen.
Custom Strategies
Two Leg (2L)
Select your Long Call leg and Long Put leg with same chosen strike as your Straddle,
make sure you enter 2 contracts for either the Long Call or Long Put, which will define
whether you have a Strip or a Strap, and make sure you have the right Expiry (April
2015)
Note the Total Price for the strategy

Derivatives
FIN 334

Professor Imerman
Spring 2015

Discussion Questions: (incorporate these into your Lab Report)

1.) For each of the option trading strategies (A, B, C, D) note the price of the strategy given
in Bloomberg and reconcile it with the individual prices given in the Option Monitor
and Option Valuation screens. Specifically, address the following for each position
making up the strategy (i.e. Long/ Short, Call/Put):
a. Are the prices for European or American options?
b. Is the Bid, Ask, Midpoint, or Last used?
2.) Take your simulated payoff and simulate the P&L for each strategy (A, B, C, D) by
subtracting/adding the net premium paid/received (from question #1 above). Identify the
following:
a. Maximum profit
b. Maximum loss
c. Breakeven point
3.) Under what conditions would you want to employ the strategy in A, B, C and D? i.e.
when does it make money; when is it riskiest? Compare the strategies in C and D.
4.) Are there any instances where using American options to construct any of the strategies
(A, B, C, D) would be riskier than using European options? Why or why not?