PowerPoint Presentation
IC301 Seminar 4
Bullish/bearish vs bullish/bearish on volatility
When investor has a view on the market, he is anticipating a price increase
When investor has a view on the market, he is anticipating a price fall
When investor is on volatility, he thinks that there will be a lot of volatility
When investor is on volatility, he thinks that there will not be much volatility
bullish
bearish
bullish
bearish
Call spread (bull spread)
Long 1 Call and 1 Short call
Directional bias is present, investor is mildly bullish
Mildly Bullish on volatility (undecided)
Used when he thinks that the price will go up until a certain level
Limited profit/loss
7 / 9
▾
Open ▾
(market price is 1.00)
1.00
1.10
A trader buys a call option for $3 on a stock with a price of $100 and sells a call option for $1 on the same stock with a strike of $120. Both options have the same maturity and notional amount. Sketch the pay-out diagram for this position. What is the maximum loss/gain on the position? What happens if the final share price is above $120 at maturity?
100
120
1
-3
If the price is above 120, the payoff is flat
Net premium: -3+ 1 = -2
If the price is 140:
(140 – 100) – (140 – 120) = 20
20 – 2 = 18
If the price is 160:
(160 – 100) – (160 – 120) = 20
20 – 2 = 18
Ratio call spread
Long 1 call and Short 2 calls
Neutral strategy
Limited profit & unlimited risk
Thinks that there will be little volatility (bearish on volatility)
Very little initial payment, a premium might even be received
(market price is 1.00)
1.00
1.10
Long Butterfly
Long 1 call, Short 2 calls, Long 1 call
Neutral strategy (neither bullish nor bearish)
Limited profit & limited risk
Thinks that there will not be volatility
(market price is 1.00)
1.00
1.10
1.20
1 Long call and 1 short put
Long synthetic forward
Used to simulate a payoff of a forward
Sometimes created to hedge a short forward
Sometimes an arbitrage opportunity
Protective put
Long the underlying
Long 1 Put
Hedging strategy
Investor is bullish on the stock
= synthetic long call
Risk and reward the same as long call
Profit Achieved When Price of Underlying > Purchase Price of Underlying + Premium Paid
Covered call
Long underlying
Short 1 call
Bullish strategy
Limited profit & unlimited risk
Thinks that the price will go up
Unless the price goes down, and he is OBLIGED to sell the shares when requested (short call), can simultaneously benefit from the premium and capital gains from the stock
Profit Achieved When Price of Underlying > Purchase Price of Underlying – Premium Paid
Long 1000 Apple shares
Close price: 175
175
Describe the different strategies involved in (i) a protective put and (ii) a covered call whilst keeping the same underlying AAPL share position. Under what scenarios for the AAPL share price outlook would you consider employing these strategies profitably?
Protective put
170
-2.71
175
Long stock
Result: synthetic call
Long Put
Explain you P/L as the price moves from 150 to 200
price 150 155 160 165 170 175 180 190 200
Stock
Long put
Total
-25
-15
-5
0
25
-10
20
0
0
0
0
0
-7.71
-7.71
-7.71
-2.71
2.29
12.29
-20
5
15
15
10
5
-7.71
-7.71
22.29
These were the latest closes for the AAPL Dec 2019 options:
Calls Strike Puts
8.15 170 2.71
5.10 175 4.63
3.00 180 7.55
Which one/ones are ITM and what are the intrinsic and time value?
Answer: 180 put is ITM with $5 intrinsic and $2.55 time value