Trading Strategies

Involving Options
Chapter 11

1 C. Hull 2013
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John

Strategies to be Considered
Bond

plus option to create principal

protected note
Stock plus option
Two or more options of the same type
(a spread)
Two or more options of different types
(a combination)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John2C. Hull
2013

Principal Protected Note

Allows

investor to take a risky position

without risking any principal
Example: $1000 instrument consisting of
3-year zero-coupon bond with principal of
$1000
3-year at-the-money call option on a stock
portfolio currently worth $1000

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John3C. Hull
2013

Principal Protected Notes continued

Viability

depends on

Level of dividends
Level of interest rates
Volatility of the portfolio

Variations

on standard product

Out of the money strike price

Caps on investor return
Knock outs, averaging features, etc

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John4C. Hull
2013

Positions in an Option & the

Underlying (Figure 11.1, page 257)
Profit

Profit

K
K

ST

(a)

ST
(b
Profit )

Profit

K
ST

(c
(d
Fundamentals of Futures and )Options Markets, 8th Ed, Ch 11, Copyright ) John5C. Hull
2013

ST

Bull Spread Using Calls

(Figure 11.2, page 258)

Profit
ST
K1

K2

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John6C. Hull
2013

Bull Spread Using Puts

Figure 11.3, page 259

Profit
K1

K2

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John7C. Hull
2013

Bear Spread Using Puts

Figure 11.4, page 260

Profit

K1

K2

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John8C. Hull
2013

Bear Spread Using Calls

Figure 11.5, page 261

Profit

K1

K2

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John9C. Hull
2013

Box Spread
A

combination of a bull call spread and a

bear put spread
If all options are European a box spread is
worth the present value of the difference
between the strike prices
If they are American this is not necessarily
so (see Business Snapshot 11.1)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John10
C. Hull
2013

Butterfly Spread Using Calls

Figure 11.6, page 263

Profit

K1

K2

K3

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John11
C. Hull
2013

Butterfly Spread Using Puts

Figure 11.7, page 264

Profit
K1

K2

K3

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John12
C. Hull
2013

Calendar Spread Using Calls

Figure 11.8, page 265

Profit
ST
K

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John13
C. Hull
2013

Calendar Spread Using Puts

Figure 11.9, page 265

Profit
ST
K

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John14
C. Hull
2013

A Straddle Combination
Figure 11.10, page 266

Profit

ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John15
C. Hull
2013

Strip & Strap

Figure 11.11, page 267

Profit

Profit

K
Strip

ST

K
Strap

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John16
C. Hull
2013

ST

A Strangle Combination
Figure 11.12, page 268

Profit
K1

K2
ST

Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John17
C. Hull
2013

Other Payoff Patterns

When

the strike prices are close together

a butterfly spread provides a payoff
consisting of a small spike
If options with all strike prices were
available any payoff pattern could (at least
approximately) be created by combining
the spikes obtained from different butterfly
spreads
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright John18
C. Hull
2013