Explain why margin accounts are only required when clients write options but not when they buy options?
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Chapter3-InsuranceCollarsOtherStrategies-Students.pptxChapter 3 Insurance, Collars, and Other Strategies
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Floors & Caps
Purchase of a put option is called a floor as it guarantees a minimum sale price of a security
Purchase of a call option is called a cap as it limits the highest amount needed to pay to buy the security
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2
Strategies to be Considered
Stock plus option
Two or more options of the same type (a spread)
Two or more options of different types (a combination)
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3
Positions in an Option & the Underlying
Profit
ST
K
Profit
ST
K
Profit
ST
K
Profit
ST
K
(a)
(b)
(c)
(d)
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4
Spreads & Combinations
A spread is a strategy where you buy or sell positions in the same type of option
A combination is a strategy where you buy or sell position in different types of options
A bull strategy is one that is designed to make money when the market rises, and a bear strategy makes money when the market falls
A volatility play makes money when there are large price swings in the market, regardless of the direction
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5
Bull Spread Using Calls
K1
K2
Profit
ST
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6
Bull Spread Using Puts
K1
K2
Profit
ST
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7
Bear Spread Using Puts
K1
K2
Profit
ST
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8
Bear Spread Using Calls
K1
K2
Profit
ST
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9
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 ([K2 – K1]e-rT)
If they are American this is not necessarily so
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Collars
A collar is the purchase of a put and the sale of a call with a higher strike price on the call than the put but with both having the same underlying asset and time until expiration
Collar Width – Difference between the call strike price and put strike price
Similar to short forward but there is a range between the strike prices where payoff at expiration is unaffected
Zero-Cost Collar – premium of call is equal to premium of put, i.e. no cost
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Butterfly Spread Using Calls
K1
K3
Profit
ST
K2
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12
Butterfly Spread Using Puts
K1
K3
Profit
ST
K2
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13
Butterfly Combination (Spread) Using Puts & Calls
K1
K3
Profit
ST
K2
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Butterfly Spread Using Puts & Calls
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Here we are using both puts and calls to generate the Butterfly spread
We long a put with a strike of K1, short a put and call with a strike of K2 and long a call with a strike at K3
Not the payoff is nonpositive, indicating we receive money when we enter into the position
This is the opposite of a butterfly spread with just calls or puts that has a nonnegative payoff and costs money today
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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
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Calendar Spread Using Calls
Profit
ST
K
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Calendar Spread Using Puts
Profit
ST
K
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Volatility Play
Speculating on volatility
Long straddle, strip, strap, strangle expect high volatility
Short straddle, strip, strap, strangle expect low volatility
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A Straddle Combination
Profit
ST
K
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Strip & Strap
Profit
K
ST
Profit
K
ST
Strip
Strap
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21
A Strangle Combination
K1
K2
Profit
ST
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