Chapter 11 Trading Strategies Involving Options Futures and

Chapter 11 Trading Strategies Involving Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 1

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) Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 2

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 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 3

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 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 4

Positions in an Option & the Underlying (Figure 11. 1, page 237) Profit K K ST ST (a) Profit (b) K ST (c) Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 K ST (d) 5

Bull Spread Using Calls (Figure 11. 2, page 238) Profit ST K 1 K 2 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 6

Bull Spread Using Puts Figure 11. 3, page 239 Profit K 1 K 2 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 7

Bear Spread Using Puts Figure 11. 4, page 240 Profit K 1 K 2 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 8

Bear Spread Using Calls Figure 11. 5, page 241 Profit K 1 K 2 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 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 If they are American this is not necessarily so (see Business Snapshot 11. 1) Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 10

Butterfly Spread Using Calls Figure 11. 6, page 242 Profit K 1 K 2 K 3 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 11

Butterfly Spread Using Puts Figure 11. 7, page 243 Profit K 1 K 2 K 3 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 12

Calendar Spread Using Calls Figure 11. 8, page 245 Profit ST K Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 13

Calendar Spread Using Puts Figure 11. 9, page 246 Profit ST K Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 14

A Straddle Combination Figure 11. 10, page 246 Profit K Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 ST 15

Strip & Strap Figure 11. 11, page 248 Profit K Strip ST K ST Strap Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 16

A Strangle Combination Figure 11. 12, page 249 Profit K 1 K 2 ST Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 17

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 Options, Futures, and Other Derivatives, 8 th Edition, Copyright © John C. Hull 2012 18