This chapter discusses various trading strategies involving options, including using a bond and option to create a principal protected note, positions in individual stocks and options, option spreads, and option combinations. It provides examples of bullish and bearish call and put spreads, butterfly spreads, calendar spreads, straddles, strips and straps. The payoffs of these strategies are illustrated through diagrams. Principal protected notes allow investors to take on risk without jeopardizing principal. Option spreads and combinations can be used to speculate on the direction of the underlying asset or to hedge exposures.

1. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Trading Strategies
Involving Options
Chapter 11
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2. 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)
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
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3. 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
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
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4. 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
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
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5. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Positions in an Option & the
Underlying (Figure 11.1, page 257)
Profit
STK
Profit
ST
K
Profit
ST
K
Profit
ST
K
(a)
(b
)
(c
)
(d
) 5

6. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bull Spread Using Calls
(Figure 11.2, page 258)
K1 K2
Profit
ST
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7. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bull Spread Using Puts
Figure 11.3, page 259
K1 K2
Profit
ST
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8. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bear Spread Using Puts
Figure 11.4, page 260
K1 K2
Profit
ST
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9. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Bear Spread Using Calls
Figure 11.5, page 261
K1 K2
Profit
ST
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10. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
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)
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11. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Butterfly Spread Using Calls
Figure 11.6, page 263
K1 K3
Profit
STK2
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12. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Butterfly Spread Using Puts
Figure 11.7, page 264
K1 K3
Profit
STK2
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13. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Calendar Spread Using Calls
Figure 11.8, page 265
Profit
ST
K
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14. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Calendar Spread Using Puts
Figure 11.9, page 265
Profit
ST
K
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15. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
A Straddle Combination
Figure 11.10, page 266
Profit
STK
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16. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
Strip & Strap
Figure 11.11, page 267
Profit
K ST
Profit
K ST
Strip Strap
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17. Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
A Strangle Combination
Figure 11.12, page 268
K1 K2
Profit
ST
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18. 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
Fundamentals of Futures and Options Markets, 8th Ed, Ch 11, Copyright © John C. Hull 2013
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