Home / Summaries / Class notes - Part 3: Financial Market and Products / straddle-k2-stock

Trading Strategies Involving Options

6 important questions on Trading Strategies Involving Options

How about trading an option and the underlying asset?

Long stock and short call (writing a covered call) = Short put + Cash
Short stock and long call (reverse writing of a covered call) = Long put - Cash
Long stock and long put (protective put) = Long call + Cash
Short stock and short put (reverse protective put) = Short call - Cash

How about bear spreads?

They work the exact opposite as the investor expects a decrease. Same expiration date but SHORT on low strike price and LONG on higher strike price. Can be done with both calls and puts, for calls there will be an initial cash inflow while there will be an initial cash outflow for puts. This makes the investment strategy cheaper.

Payoffs:
- St<K1 - - > K2-K1
- K1 < St < K2 - - > K2-St
- St > K2 - - > 0

What about box spreads?

Combination of bull and bear that create a payoff of K(High) - K(Low) in all cases. In general the value should be equal to the expected payoff of (k2-k1)*e^-r*t. Note that the arbitrage only works with European options as the value of American put options is not equal to Europeans.

Payoffs: always K2-K1

What about diagonal spreads?

A lot of different patterns by taking different maturities as well as different strike prices still only call or only put.

What about a straddle

V-shape pay-off. Going long in both put and call for the same strike price and the same maturity. Expecting a large price move but uncertain about the direction. Also called bottom straddle or straddle purchase. Top straddle or straddle write is the reverse position, meaning that you both on no or small move. Note that the risk can be unlimited.

Payoff:
St<K - - > K - St
St=K - - > 0
St>K - - > St - K

What about strips and straps?

Kind of a straddle but then a particular preference for bull or bear. In case of bull it is a strap with 2 calls and 1 put. In case of bear it is a strip with 1 call and 2 puts.