Option Strategist Exercise 4: Option Trading Strategies
Using the CME Strategy Guide
Trading options involves taking a view of both the direction of the underlying and the magnitude of the volatility of the underlying. In this exercise we will set up positions, using the CME guide, to take advantage of expected changes in these two market variables. This will give you practice in changing existing exposures by buying and selling other options:
Underlying: GBP/USD
Price quoted in USD
Contract size: £1,000
European Option
Options on cash
One tick = 1/10,000 of quoted price
Value of one tick = 0.1 USD
USD Year basis = 360 days
GBP Year basis = 365 days
For all of the following positions use 1000 contracts (£1,000,000) per leg of the spread and 30 day maturities
You are bullish and you believe that volatility is rising so you buy a 1.69 strike call option on Cab
Cable spot rate 1.69
Volatility 20%
US Interest Rates 5%
UK Interest Rates 5%
For all of the following follow-up strategies use the CME Strategy guide. For each new position you should be noting down the delta, gamma, theta and vega exposures.
You are still a buyer of volatility but have turned bearish on the market.
Follow-up trade:sell 1000 futures @1.6900
New position: Long put
Delta
Gamma
Theta
Vega
–
+
–
+
Restore the call position. You are now undecided on volatility, but mildly bullish on the market.
Follow-up trade:Sell call with strike 1.7100
New position:
Delta
Gamma
Theta
Vega
+
0
0
0
2. You would like to be net short volatility but do not want exposure to upside or downside directional risk. Set up a long butterfly using puts with 1.65, 1.69 and 1.73 strikes.
Delta
Gamma
Theta
Vega
0
–
+
–
You become bullish on the market but you now think that volatility will drop.
Follow-up trade: sell 1.73and1.65 puts
New position: Short put
Delta
Gamma
Theta
Vega
+
–
+
–
b) Restore the long butterfly. You are now bearish on the market but undecided on volatility
Follow-up trade: sell 1.65 and buy back 1.69 puts
New position: Put bear spread
Delta
Gamma
Theta
Vega
–
0
0
0
3. You think that volatility is at low levels and that the market will rally but you don’t want to pay out to buy volatility so you set up a call ratio backspread (2:1)using 1.69 and 1.75 strike calls.
Delta
Gamma
Theta
Vega
+
+
–
+
a) You are still bullish on direction but are now undecided on volatility.
Follow-up trade: sell 1 call buy 1000 futures@1.69
New position: Split strike synthetic long future
Delta
Gamma
Theta
Vega
+
0
0
0
b) Restore the backspread. You want to remain long volatility but are now bearish on direction
Follow-up trade: Buy 1.69 strike put, sell 1.77 strike call
New position: Put backspread
Delta
Gamma
Theta
Vega
–
+
–
+
You are bullish but have no view of volatility so you set up a long futures position.
Delta
Gamma
Theta
Vega
+
0
0
0
a) You remain bullish but are now a buyer of volatility.
Follow-up trade: Buy a 1.69 strike put
New position: Long call
Delta
Gamma
Theta
Vega
+
+
–
+
Restore the futures position. You have no directional view but want to be short volatility.
Follow-up trade: Sell 2000 1.69 strike calls
New position: Short Straddle
Delta
Gamma
Theta
Vega
0
–
+
–
c) Restore the long futures position but this time create a synthetic futures contract using 1.69 strike puts and calls.
Delta
Gamma
Theta
Vega
+
0
0
0
d) You have no directional view but want to be long volatility.
Follow-up trade: Buy 2000 1.69 strike puts
New position: Long straddle
Delta
Gamma
Theta
Vega
0
+
–
+
Restore the long synthetic futures position. You are now bearish and believe that volatility will fall.
Follow-up trade: Buy back put, sell 2000 1.69 strike calls
New position: Short call
Delta
Gamma
Theta
Vega
–
–
+
–